Category Archives: Accounting and Audit

The Hungarian Trust Law – An Anglo-Saxon Legal Institution in Civil Law Environment

The new Hungarian Civil Code (Act No. V of 2013) came into effect on 15th of March 2014. The Civil Code regulates the fiduciary asset management contract, a very similar legal institution to the Anglo-Saxon trust. The concept of the Hungarian trust was drawn up on the basis of the model of the trust in English law and that of the Treuhand in German law. The introduction of the fiduciary asset management on a legislative level is necessitated by strong, current demand in the economy. We have observed that several Hungarian investors chose legal regimes of other countries because the institution of the trust provided them with a better legal and economic solution. Now there is an opportunity to establish trust also in Hungary, a civil law country.

The new Hungarian Civil Code sets out a contractual arrangement and its validity is bound to a written contract. The regulation is of a general scope and several details are regulated in two further separate pieces of legislation. Such details are regulated in Act XV of 2014 on Trustees and the Regulation of Their Activity, and in Government Decree No 87/2014 (III. 20.) on certain rules concerning the financial security of fiduciary property management undertakings.

Chief features of the Hungarian trust

Under the fiduciary asset management contract, the trustee has the duty to manage the property transferred to his ownership by the settlor in his own name, for the benefit of the beneficiary, for which the settlor is obliged to pay a fee. The managed asset can be things, rights and claims as well. If the settlor and trustee are one and the same person, fiduciary asset management is established by the irrevocable unilateral declaration of the settlor set out in a public instrument. A legal relationship of property management settled by testament is established by the trustee’s acceptance of his appointment to such position, under the terms set out in the testament.

In the legal relationship of the asset management, it is also possible to set out other conditions, such as its duration, which is maximum 50 years, terms, right of unilateral termination, remuneration of the trustee, appointment of additional trustees, regulation of the delegation of other agents, and the beneficiary’s right to transfer. The settlor reserves the right to remove the trustee, appoint a new trustee, replace the beneficiary, modify given parts of the settlor’s declaration, and to determine or modify the duration of property management.

The settlor and also the beenficiary may monitor the activity of the trustee falling within the scope of property management, but the costs of such monitoring are incurred by the settlor. It is a mandatory rule that the settlor may not instruct the trustee. The settlor, however, may remove the trustee from office at any time, and simultaneously appoint another trustee.

Trust companies

Act XV of 2014 distinguishes professional and ad hoc asset management. An undertaking contracting on a regular basis for fiduciary property management at least twice annually, or for a property management fee in excess of one per cent of the value of the trust property on the date of the contract, or for any other financial gain, may carry out fiduciary asset management only in possession of the licence issued by the National Bank of Hungary prior to the start of such activity. The professional fiduciary asset managing company can be only a limited liability company or private limited company with a registered office in the territory of Hungary, or the branch – registered in Hungary – of an undertaking based in another contracting state of the Agreement on the European Economic Area.

The fiduciary asset management company may not carry out activity other than asset management, and its name must make reference to property management. The company must hold the licenses required for such activity. The fiduciary asset management company is required to fulfil strict staff and equipment requirements to receive the authorisation of the National Bank of Hungary.

The rights and duties of the trustee

Under the contract, the trustee may not be the sole beneficiary. The settlor and the trustee, however, may be one and the same person. The trustee has the duty to provide information, manage the property as instructed in the declaration of the settlor, avoid conflicts of interest and manage the property separately from his own. If the trustee is authorised to designate the beneficiary under the contract, the trustee has the right to determine the share of the beneficiary.

Due to stricter requirements arising from the fiduciary nature of the legal relationship, the trustee has the duty to act in utmost consideration of the interests of the beneficiary. The trustee has the duty to protect the trust property against foreseeable risks in a commercially reasonable manner.

The management of the property includes the exercise of rights arising from ownership, other rights and claims transferred to the trustee, and the fulfilment of obligations arising therefrom. The trustee may dispose of the assets belonging to the trust property under the conditions and within the limits sets out in the contract.

The trustee has a duty to keep confidential any fact, information and other data he becomes aware of during his appointment as trustee or in relation thereto. Such obligation is without prejudice to the establishment of the trusteeship and remains in effect after the termination of fiduciary property management. The settlor and his successors may grant exemption from the confidentiality obligation.

The trustee has the duty to inform the settlor or the beneficiary of the trust property upon their request. Upon request, the trustee has the duty to account for the trust property, and settle accounts with the settlor and beneficiary. Costs incurred in connection with the provision of information and the payment of invoices are borne by the settlor and beneficiary.

The trustee is liable for the fulfilment of the undertaken obligations with the trust property. The trustee assumes unlimited liability with his own property for the satisfaction of claims arising from commitments charged to the trust property, if these cannot be satisfied from the trust property, and the other party was not and could not have been aware that the commitments of the trustee exceed the limits of the trust property.

If the settlor appoints several trustees, the actions and decisions of the trustees are taken jointly. If the trustees are also liable with their own property for their commitments, they assume joint and several liability for joint decisions toward third parties. Several trustees assume joint and several liability toward the settlor and beneficiary for the breach of obligations arising from fiduciary property management.

Asset partitioning

The trust property constitutes property separate from the trustee’s own property and other property managed by him, which the trustee is obliged to register separately. The parties’ derogation from this rule is void. Assets registered as property managed separately from the trustee’s own property and other property managed by him are deemed to fall within the scope of trust property until proven otherwise. Any assets substituting the managed assets, insurance indemnities, damages or other value, and profits thereon, constitute part of the trust property, whether registered or not.

As a general rule, the creditors of the settlor may not lay claim to the trust property, unless the settlor is also a beneficiary. In respect of the contract between the settlor and the trustee, the creditors of the settlor may assert claims in accordance with the modern rules of actio Pauliana, under the general rules of the law of obligations. In exceptional cases, the aforementioned Act XV of 2014 also allowed the termination of the asset management contract in the execution procedure launched against the settlor.

Pursuant to regulation in the Civil Code, which corresponds to the rules of common law, in the event of the trustee’s insolvency, the creditors of the trustee may not lay claim to the trust property. This rule is also applicable to the spouse, partner and successors of the trustee. The trust property does not constitute part of the trustee’s inheritance either. This regulation provides asset partitioning for the trustee which resembles to the Anglo-Saxon trust rules.

The creditors of the beneficiary clearly have the right to take action against the trustee, quasi under the legal title of the beneficiary. This is possible only if the right of the beneficiary to receive from the asset managed is due. It is difficult to determine the claim of the beneficiary’s creditors in relation to the beneficiary’s claim in the trust property, if the trustee holds discretionary power with respect to the management of the property, because the claim of the beneficiary is also uncertain and unascertainable in such a case.

Tracing

The settlor and the beneficiary have the right to take action against third parties to whom the trustee transferred property in breach of the asset management contract, gratuitously or in bad faith. Such regulation essentially corresponds to the rules of common law tracing in English law.

Is the Hungarian trust a real trust?

Overally yes, in minor details no. The Hungarian fiduciary asset management has the same function as the English trust, the asset partitioning, the tracing, the trustee’s office are regulated very similarly. On the other hand in the Hungarian regulations we can experience several smaller differences. Under the new Hungarian Civil Code, the fiduciary asset management contract mostly resembles the express trust. Conditions give rise to a resulting trust only in exceptional cases, while the constructive trust and charitable trust are not regulated. This is, to a certain extent, understandable, as under Hungarian private law, these legal situations are regulated with the institutions of unjust enrichment, foundations and public donations.

The fiduciary asset management contract must be made in writing, while the Anglo-Saxon trust may be created orally or by implied conduct. In view of the fact that fiduciary asset management is a new legal instrument in Hungarian law, we believe it is reasonable that the contract is bound to a written form to avoid any legal uncertainties.

The new Hungarian Civil Code does not set out expressis verbis that the settlor has the right to revoke fiduciary asset management, while in Anglo-Saxon law, the settlor retains this option during his lifetime, if he laid this down in the deed of trust.

Under the new Hungarian Civil Code, as a general rule, fiduciary asset management is a contract for consideration, while Anglo-Saxon law presumes gratuity, unless provided otherwise.

Under the new Hungarian Civil Code, the fiduciary asset management contract has a maximum duration of 50 years. A time limit is also applied in English law, with the exception of the charitable trust. International trends, however, increasingly suggest a loosening and elimination of time limits.

According to the principle derived from the Saunders v. Vautier case, the beneficiary is entitled to the distribution of the trust property if he is of legal age and does not breach the interests of other beneficiaries. This rule is not applied in the Hungarian law.

Conclusion

We have to come to the conclusion that the Hungarian regulation of fiduciary asset management contract is mainly convenient to the Anglo-Saxon trust. We have to emphasise that the Hungarian trust regulations functionally are in accordance with the English law principles. We can find high-level regulation of asset partitioning, the trustee’s office and the rules of tracing. Some critics may expressed on the obligatory registration of the trust, which can be explained by chariness of the legislators. Overall the Hungarian trust can fill out the main functions of the English trust in the economy.

I suppose that the Hungarian trust-like legal instrument will gain ground step by step in the near future, which will contribute to the economy and the international business relationships of Hungary as well.

Innovative Solutions To Circumvent Burdensome SPLA Requirements

Many online service providers are well aware that Microsoft’s Services Provider License Agreement (SPLA) entails a licensing framework that can be difficult to manage. SPLA may be a great model for businesses seeking to “float” their license expenditures from month to month based on usage. However, what Microsoft considers “usage” and what most companies and individuals consider “usage” can be very different. The result is that monthly SPLA-reporting obligations can be very burdensome, especially for products licensed on a per-user basis under Subscriber Access Licenses (SALs).

Fortunately, there are developers who are beginning to offer products that may help some companies to better manage and even reduce or eliminate some expenditures under SPLA. For example, relatively new to the market is a product called Winflector, which might be a candidate for service providers interested in a replacement for Windows Remote Desktop Services (RDS) SALs under SPLA. Ordinarily, a SPLA licensee must assign an RDS SAL to each user who is authorized to directly or indirectly access RDS. It is critical to note that the licensing requirement is triggered based on authorization to access RDS and not on actual usage of the service. Therefore, if a service provider with a billing model that is based on actual usage of a product incorporating RDS sets up ten accounts for a customer, the provider can run into trouble if only three of that customer’s users actually access the product in a reporting month. Since ten accounts are active, Microsoft would expect the provider to report ten SALs, even though only three users actually accessed RDS. Winflector may be a solution for service providers in that situation to consider, because, according to its developer, it does not make any use of RDS. Instead, the service provider’s application is deployed and configured on a server that is also running the Winflector server product. The customer’s users then run a Winflector client application and use that application to access the hosting server.

Of course, products like Winflector may not be good fit for all service providers. The requirement of a client-side application may be a deal-breaker, and while Winflector’s license model may be represent long-term cost savings, the product is not free and likely would represent a capital expenditure rather than an operating expense. Nevertheless, new offerings like Winflector are promising developments for many service providers. Some of Microsoft’s SPLA-licensing policies seem designed to squeeze SPLA licensees out of the hosting business and into the business of reselling Microsoft’s own hosted services. These kinds of technological options could be answers for companies seeking to continue operating under existing business models.

Does it feel better to know for certain that you are a tax audit target?

Law Firms and Accountancy Practices using Discretionary Trusts

In September 2014 the Tax Commissioner released a document headed “Assessing the risk: allocation of profits within professional firms.”

In broad terms, the Commissioner is very unhappy that professional firms can use trusts and other structures so that less tax is paid than if the relevant profits were taxed directly in the hands of the individual lawyers or accountants who own the business.

The ATO position is that professionals who structure their firms as partnerships of discretionary trusts, for example, may be doing so for the dominant purpose of getting a tax benefit, so that the anti-avoidance rules in Part IVA of the Income Tax Assessment Act 1936 will apply.

Why it is that professionals who use discretionary trusts may now be tax avoiders when the hundreds of thousands of other businesses operating through trusts with owners who provide skilled input are not targeted by the ATO campaign has not been fully explained.

We do know that the ATO has had professionals and income generated from personal services on its radar for more than 30 years, through cases like Everett, Galland, Tupicoff and Mochkin (and many others), multiple tax rulings and the introduction of the Personal Services Income (PSI) regime in 2000.

The law in this space can be stupendously complex, but what the ATO is now saying (as best we can understand it) is this:

  • If you are a sole practitioner and operate through a discretionary trust (for example) and the PSI rules don’t otherwise apply, the ATO may apply Part IVA to tax you on the trust income personally, on the basis that all that income is generated by your effort and skill;
  • If you are involved with a firm that has discretionary trust partners and the ATO accepts that the firm income is generated by a “business structure” (because of its size or number of employees, for example) the ATO says that you must still be taxed on those parts of profit that accrue to the discretionary trust partner which represent the income derived by the firm from your professional input.

Just how you work out your value to the firm is another question, but the Commissioner has sidestepped that issue by providing us with these guidelines which tell us the ATO view of the tax outcomes that can make you a low risk audit target.

Low Risk

The ATO says you will not be audited for Part IVA purposes if one of the following tests is satisfied:

  • You receive income representing an “appropriate” return for your services to the firm – perhaps equal to the highest paid employee or reflecting industry benchmarks;
  • 50% or more of the income which flows to you and associated entities is taxed in your hands; or
  • Your associated entities and you have an effective tax rate or 30% or more on income from the firm.

High Risk

If you can’t tick the box on even one of these three tests you become a high risk, high priority target for a tax audit and the application of Part IVA.

What to Do

The Commissioner’s campaign is targeting 2015 and later financial years, so the ATO is providing a clear choice for professionals using these structures – roll on as before and prepare to engage with the ATO auditors when they come knocking, or satisfy one or more of the tests in the ATO guidelines, pay more tax for 2015 and beyond, and continue to enjoy the quiet life.

Knowing Where The Liabilities Are Buried: Issues For The Public Sector Implementing Accounting Standard PS 3260

With the requirements of the Public Sector Accounting Board’s “Accounting Standard on Liability for Contaminated Sites” (PS 3260) applying to the 2014-2015 fiscal year, public sector entities (federal, provincial and municipal governments, universities, schools and hospitals) may find themselves scrambling to meet their obligations to identify, report and account for long forgotten buried liabilities. Under PS 3260 public sector entities must now account for the remediation liabilities associated with “contaminated sites”, which are sites where contamination exceeds the applicable environmental standards, but does NOT include closed solid waste landfill sites that are subject to a separate standard. PS 3260 requires that an estimate of remediation liability be included for all such contaminated sites that are no longer in active or productive use, and for which a public sector entity is responsible either as a result of legal or voluntary assumption of remediation obligations.

For example a municipality that owns an inactive maintenance shop and yard where the bulk storage of fuel, road salt, waste oil, etc. and the storage and servicing of municipal vehicles may have resulted in past releases of these contaminants at the site is likely required to identify the yard as a contaminated site under PS 3260, and would also be required to develop and provide an estimate of remediation liability for the site.

Clearly a key issue for most entities implementing PS 3260 is that there may be a lack of information not only about the sites that should be considered to be “contaminated sites” but also regarding the nature and extent of remediation liability. A critical first step for meeting the requirements of the standard is to prepare an inventory of all active and inactive potential sites with an “environmental past”. This task involves gathering all available information about such sites such as records of use, ownership, environmental site assessment reports, information from regulators, incident reports, etc. to determine whether a given site would constitute a contaminated site under PS 3260 and the public sector entity could incur liability as a result.

While preparing the inventory, information gaps will likely be identified that require existing records to be supplemented, particularly for sites with a long history of use, where the site history is unknown or where the site was subject to multiple owners, multiple uses or both. In particular, assessing whether a given site meets the criteria for a contaminated site under PS 3260 requires specific information regarding the likelihood, nature and extent of contamination at that site, and this may require the commissioning of environmental site assessments to identify and delineate whether the site has been contaminated. In addition, assessing whether a site meets the criteria also requires an understanding of the specific legal and voluntary obligations of the public sector entity for the site and for the type of contamination identified.

When a public sector entity has concluded that a given site does meet the criteria for a contaminated site under PS 3260, a reasonable estimate of the financial costs directly attributable to carrying out the required remedial actions must also be developed. Although there is some guidance provided in the standard with respect to what types of costs should be included in a remediation liability assessment, in order to yield an accurate, reasonable and defensible liability estimate, issues such as the treatment of long-term monitoring costs and the application of various types of discounts, contingencies and escalation factors are all dependent on the exercise of professional judgment and the development of reasonable working assumptions. Identifying sites and preparing liability estimates requires specialized technical and legal advice as the process of accounting for environmental liabilities remains much more of an art than a science.

Although the standard was introduced some time ago, with four years given to prepare public sector entities for the initial reporting period of 2014-2015, this issue appears to have remained a bit of a “sleeping dog.” Consequently, indications from external auditors and environmental consultants are that public sector entities may have considerable difficulty meeting their obligations for the initial reporting period. For those public sector entities that find themselves caught short by these requirements, there is still time to get the required information gathering and assessment underway, but the window for taking such steps is rapidly closing.

Tesco’s Accounting Scandal a Lesson for All Public Companies

Britain’s biggest retailer faces a crisis situation two weeks after announcing that it overstated its first-half profit expectations by some £250-million. Tesco PLC, the multinational grocery and retail giant headquartered in England, reported on September 22, 2014 that its August 29 profit warning should have forecasted trading profit totalling £850-million, rather than the £1.1-billion that the company actually reported – an inflation of nearly 25%. The market reacted swiftly, and as of October 7, 2014 had knocked 20% (a total of about £4-billion) off the value of Tesco shares. On October 1st, Britain’s financial regulator, the Financial Conduct Authority, announced that it has launched a full investigation into the accounting scandal. As the company rushes to contain the situation and events continue to unfold, it is already clear that this is a classic example of the potentially explosive risks that public companies face every time they prepare and report their financial status to the market.

Tesco has been for years the world’s second largest retailer after Walmart, though in recent times it has faced stiff competition in Britain and Europe, together with declining profits. Its September 22 announcement was the latest and most impactful blow to Tesco’s market value and reputation. Tesco has stated that the profit overstatement was caused by apparent accounting errors – including the early booking of revenue and delayed recognition of costs – which were discovered during the preparation of its forthcoming interim results. Those results have now been delayed from October 1 to October 23. The company has already begun an independent investigation into the accounting irregularities. Four senior-ranking Tesco employees have been placed on leave while the investigation proceeds. The accounting error and misreporting, together with the precipitous drop in share value and subsequent investigations, have been widely reported in the business pages around the world.

The situation unfolding at Tesco is a prime example of how the public may react to adverse news in unpredictable ways. Even after the change to its reported profit, Tesco was still profitable. In that sense, the market’s reaction could be seen as disproportionate. However, the news has clearly shaken public confidence in the company. Commentators have suggested that in the context of the other challenges facing Tesco, it may be an indicator of deeper-lying and more serious problems. Tesco’s share price seems to have been punished so severely not because the profit in one quarter was overstated, but because people are now saying “I don’t know what I don’t know” about the company in light of the fact that this happened. The same scenario has been played out numerous times in Canada (Biovail, SNC Lavalin and others) and elsewhere. It is also likely that the market has factored in that this situation will inevitably engender other expensive and distracting consequences, including the freshly initiated regulatory investigation and rumblings of a possible class action.

Public companies must ensure that they have in place a strong corporate governance culture and robust internal systems designed to prevent accounting and other problems. Commentators have long held that the “tone at the top” is a key factor contributing to the integrity of the financial reporting process, and companies are well advised to have a careful look at the adequacy of their internal controls on a regular basis. It is always preferable to manage and minimize risk than to have to respond to a crisis. Having said that, no company, however well run, is immune to crises. Without knowing more, it is impossible to say whether the situation at Tesco could have been prevented. What is clear is that, as the Tesco case now demonstrates, a company cannot unring the bell once news of an irregularity has broken. Instead, Tesco must scramble to react to a growing crisis. People will continue to watch with interest to see how, and how well, Tesco is able to weather this storm.