The International Journal
of Not-for-Profit Law

Volume 1, Issue 2, December 1998

1. “Public and Private” Debate Revisited

The multi-religious and ethnically colorful civic organizations of Hungary which flourished before the Second World War, began to develop again in the second half of the 1980s after a forty-year Sleeping Beauty’s dream. The legal form of a foundation goes back to the Hungarian Civil Code–and thus to the legal practice of 1987 as the first sign of change. The Right of Association Act–in accordance with the International Covenant on Civil and Political Rights–was a decisive legal milestone of the change in the regimes in 1989. In 1993 with the reform of the Civil Code new legal forms of not-for-profit organizations (hereinafter NPOs) were introduced: public law foundation, public benefit company and public law association.

During the often painful economic transition to market economy the state was forced to decrease its budgetary expenses and tighten the scope of public services–mainly human services. As the purchasing power of citizens is not expected to increase in the short run, it would not be useful to privatize these services to business organizations. NPOs using partly the state and partly private financial resources could provide these services for lower prices. But this kind of privatization of public services was impeded for a long time, because of the lack of proper legal framework on transparency and accountability of NPOs. The debates about “public benefit” service-providing came into the agenda of the Hungarian politics after 1995.

After the 1996 legislation enabling NPOs opportunity to receive one percent of the personal income tax was adopted, the Hungarian Parliament passed the Act CLVI of 1997 on Public Benefit Organizations on 15th December 1997. In delivering the Bill to Parliament the Hungarian Government demonstrated its interest in strengthening civic organizations. The effect of the legislation, however, rests on NPOs themselves, from whom transparency and accountability is required by the Act, and on the awareness of the corporate community, to whom a new “covenant type” tax benefit has been given. Nevertheless, the implementation phase will be decisive, because the Act imposes additional work on an overloaded judiciary. The release of a government decree on NPO related procurement is also necessary.

2. Legal Structure of Civil Society

2.1. Structure of Legal Regulation

Although the legal framework of NPOs has already evolved in Hungary, the work is not finished yet with regard to the details. The structure of this legal framework is the following:

• The constitutional provision on freedom of association, which was modified in 1990 and the Act on Freedom of Association, which is an act basically with the same legitimacy as the Constitution, are at the top of this structure.
• Provisions of the Civil Code regulating civic organizations and the separate acts establishing public law associations (QUANGOs) form the ridge of the regulation.

The Act on Public Benefit Organizations may be regarded as a pass over the ridge. This Act is a spectral legislation linking together private and public law regulations. It defines the scope of public benefit organizations and determines the fiscal preferences to which they are entitled. The Acts on personal income tax, corporate taxes and other revenues can be found on the other side of the pass. These public law regulations determine the extent and terms of preferences related to public benefit organizations.

2.2. Public Benefit Legal Status

The Act on Public Benefit Organizations (hereinafter the “Act”) establishes a new category within NPOs. By creating the category of public benefit organizations, the Hungarian Parliament delimited public benefit organizations (hereinafter PBOs) and mutual benefit organizations (hereinafter MBOs) from each other. The objective of the distinction was to provide equal opportunity in receiving direct and indirect state support. The Act realized this goal by establishing a qualification system.

The Act contains rules on qualification–procedural requirements–on one hand, and rules on operation–substantive requirements–on the other hand. The basis of the qualification is not the difference between the types of organizations, but the delimitation of activities. The outcome of qualification is a new status, namely the public benefit status. This new status gives rise to rights as an opportunity for receiving state support, and to duties, consisting of a system of terms and guarantees.

The Act guarantees to all PBOs those tax preferences, which were previously granted only to foundations. These are tax exemption for core activity, tax benefits for related and unrelated business activities, tax credit for individuals for their donations, tax deduction for business entities for their donations, an opportunity to receive one percent of taxpayers’ income tax, and tax exemption for recipients of PBOs’ donations.

The Act also introduces a new type of tax preference, similar to the English “covenant.” “Durable donation” is financial support based on a written contract concluded between a PBO and its donor. In such a contract, the donor, being a private individual or a legal entity, undertakes the obligation to provide support of steady or higher amount of money for a four years long period without valuable consideration. The tax preference in case of durable donations is higher than in case of ad hoc donations.

The procedural requirement of public benefit status is registration: Organizations falling under the scope of the Act can be registered, but only if they undertake the public benefit criteria prescribed by the Act.

The substantive requirements relate to the provision of public benefit operation. On the one hand, public benefit status is not only connected to the undertaking of a “public purpose” prescribed by the Civil Code, but also to the pursuance of a public benefit activity enumerated in the new Act. On the other hand, it does not only mean the undertaking of duties set forth in the governing documents, but also the compliance with the operational and management order determined in the Act.

According to the Act, public benefit status is not mandatory, but based on a voluntary undertaking. Public disclosure is a basic requirement, which is manifested during the performance of the accounting obligations. Accordingly, PBOs are required to file public benefit annual reports. These reports are open to the public and, can be examined by anyone upon request.

Within the classification of PBOs, the Act creates a separate category for PBOs undertaking state responsibility. Organizations, pursuing a public benefit activity, which is qualified as the duty of a state agency or a local government by an act or a government decree authorized by an act, qualify as prominently public benefit. These organizations are entitled additional fiscal benefits, but must meet stricter requirements of public disclosure.

3. Act on Public Benefit Organizations

3.1. Scope of Public Benefit Organizations

The scope of the Act does not extend to those legal entities that belong unambiguously to the state sector (legislative and administrative bodies, central and local government agencies), or the business sector (civil law partnerships, business corporations, and cooperatives pursuing business activity). Similarly the Act does not affect organizations which, although NPOs, primarily pursue business activity (condominiums, housing cooperatives, building societies, pasturing associations).

Consequently, the scope of the Act extends to civil society organizations, foundations, public law foundations, public benefit companies, and in certain cases, public law associations (QUANGOs). From civil society organizations and foundations, the Act excludes those organizations which operate only in the interest of their membership (MBOs). In addition, the Act explicitly excludes those types of organizations, which can be considered as MBOs with regard to their core activity. These are insurance associations, political parties, and interest groups of employers and employees. QUANGOs, which operate on the borderline of non-for-profit and state sector, are given the option to operate as PBOs on the basis of their establishing acts’ authorization.

3.2. Criteria of Public Benefit Status

Public benefit criteria must be included in the governing documents. These criteria basically limit the activities of PBOs related to accessibility of services, to business activity, to distribution of profits, and to political activity.

The Civil Code regards every core activity which is not a business activity as an activity serving a “public purpose.” Thus, it identifies core activity with public benefit activity. To the contrary, the new Act exhaustively enumerates public benefit activities and regards only those core activities which are on this list as public benefit. Twenty two different activities fall into this category, ranging from health care, education and human rights advocacy, to road construction.

Consequently, the Act differentiates between core and public benefit activities. The scope of public benefit activities is narrower than the scope of core activities. PBOs may also pursue such core activities which serve a “public purpose,” but which do not qualify as a public benefit activity. PBOs may also pursue business activity. Every “economic activity which is directed to or resulted in acquisition of income or assets” qualifies as business activity if it does not belong to the sphere of the core activity. The differentiation based on PBOs activities is necessary because tax laws grant different preferences to different kinds of activities.

3.3. Rules of Public Benefit Operation

Within the framework established by the Act, public benefit operation is left to be determined by the organizations themselves. The rules on operation and management of PBOs are “minimum requirements”, ensuring the accountability and transparency of the organizations.

The rules of operation affect the activity of the highest body, the order of internal supervision, the conflicts of interest of operating officers, and the rules of fund-raising. The rules of management relate to distribution of profits, undertaking public duties, business activity, credit borrowing, investment activity, keeping records, and accounting.

In the framework of public benefit management the Act prescribes that PBOs may only receive support from subdivisions of state budget on the basis of a written contract. The terms and manner of accounting for the support must be settled in such contracts. The Act also declares that the availability, amount, and terms of support derived from the central budget or local government budget must be published in the press. Information concerning grants provided by PBOs are also available to anyone.

4. Registration and Supervision

4.1. Registration of PBOs

Public benefit status can be acquired voluntarily, on the basis of an application. The governing documents of the applicant must contain the public benefit criteria and the guarantees of public benefit operation and management, as set forth by the Act. In the application the organization must indicate the public benefit category, in which it intends to be registered.

Public benefit registrations are kept by courts deemed competent for registering organizations. Similar to the registration of organizations, courts decide on public benefit registration in an extra-judicial procedure, out of turn. The data of the court registry will be supplemented with the data of the public benefit registry.

Registration can be refused only if the governing documents of the applicant are not in conformity with the law. Rejected applicants may seek a legal remedy through a judicial procedure.

4.2. Supervision of PBOs

The supervision of PBOs takes place within the system of general supervision of NGOs. The Act on PBOs basically only supplements that. Accordingly, the Taxation and Financial Control Office exercises financial supervision, the National Audit Office controls the spending of budgetary resources, and the public prosecutor has the power of general supervision.

The public prosecutor’s powers of general supervision are extended to include supervision over the provisions of the Act on PBOs. It means that the public prosecutor may oversee the existence of public benefit criteria and the compliance with the operational and management order.

In accordance with the Act on Public Prosecutors, the public prosecutor may issue a notice or a warning to the organization, or lodge a protest against the decisions of the organization’s governing body. On the basis of the Act on Public Benefit Organizations, he may also initiate the re-ranking of the organization to the lower public benefit category or he may initiate even the deletion of the organization from the public benefit registry. However, these motions can be put forward only if the organization did not cease its unlawful operation or spending despite the public prosecutor’s warning.

The court decides on the termination of public benefit status on the basis of the public prosecutor’s proposal or the request of the organization. A PBO has the obligation to initiate within 60 days the re-ranking of the organization to the lower public benefit category, or its deletion from the public benefit registry, if its operation does not comply with the public benefit criteria. The court decides on the request of the organization or the initiation of the public prosecutor in an extra-judicial procedure, out of turn. The judicial decision is subject to appeal at a judicial procedure.

5. Virtues and Deficiencies of the Act

5.1. Virtues

The Hungarian Act is a pioneering piece of legislation in Central and Eastern Europe. A similar draft exists in Poland and a less general act was adopted in the Czech Republic. A comprehensive civil law draft was prepared in Bulgaria and a rather retrograde act was passed in Slovakia. In Romania the Law 21 of 1924 on Legal Persons (Associations and Foundations) was re-entered into force and its review is in process.

The significance of the Act is that it ensures the accountability and transparency of NGOs receiving direct or indirect state support. This is achieved by determining the registration system of operation and management, introducing the obligation of filing an annual public benefit report, and making these reports available to the public. The duty of accountability to the public creates competition among PBOs in the market of support and services to the public.

In comparison with the previous practice, the Act orders the mandatory conclusion of support contracts, which serves as a basic guarantee of accountability. Ensuring the public nature of public benefit grants makes the system of public support transparent. These rules set obligations not only for PBOs, but also for central and local government agencies. Moreover, they extend the requirement of public disclosure not only to support derived from the subdivisions of state budget, but also to support granted by PBOs.

Although the Hungarian Act does not affect the accession to the European Union, it indirectly contributes to the European integration of the country. This is so because, in contrast with business corporations, no obligation of legal harmonization exists in the field of regulating NGOs. However, customs form an important field of the legal harmonization and there are considerable debates on taxation and duties in the European Union. Following the accession, it won’t be possible to provide the same significant fiscal preferences as before accession.

5.2. Deficiencies

International and domestic experiences equally demonstrate, that the basic problem of public benefit management is the prevention of distributing profits in the guise of expenses. Although the Hungarian Act explicitly declares the prohibition on distribution of profits, it does not provide effective measures to ensure this prohibition. The Act chose the provision of public disclosure instead of specifying the prohibition. Public disclosure is a necessary, but not a sufficient mean to enforce the prohibition on profit distribution. In this field, the Act would be required to provide detailed rules, which could be sanctioned.

In order to ensure public disclosure, the Act declares that public benefit reports are available to the public. However, this solution does not grant adequate protection against intentional abuses. It would be better, if public benefit reports were deposited at a state organ, similarly to financial reports. This organ would treat them as data of public interest and would ensure their availability properly. Courts keeping public benefit registry, or public prosecutor’s offices exercising general supervision, could be the right solution for this purpose.

A serious deficiency of the Act is that it does not provide a legal concept of “donation.” Thus it does not distinguish between donations and sponsorship. In Hungary, the current judicial practice applies the rules related to gifts for both donations and sponsorship. However, a gift is a unilateral legal act and the receiver can use it without any restrictions. In contrast with a gift, a donation must serve a public benefit activity and the donor is entitled to tax preferences only if the receiver of the donation certifies the delivery of the donation in writing. In addition to that, while a donation has a purpose, sponsorship usually promotes the pursuance of an activity, and is often granted for return service, therefore it can not be seen as a unilateral legal act.

Although, due to the definition of PBOs, they cannot be regarded as final users of goods and services, the opportunity for reclaiming Value Added Tax (VAT) was not listed among the tax preferences. In addition, the system of preferences does not extend to contributions having the character of taxes, like cultural or rehabilitative contributions, or contributions for vocational training in Hungary. The extension would make sense because the reasons for this kind of exemptions and tax preferences are identical, namely, the fiscal support of public benefit activities.

6. NGO Policy of the New Government

The Hungarian national elections that concluded with the second round of voting in May 24, 1998 produced the defeat of the ruling Socialist-Liberal coalition, and the victory of a new center-right coalition, led by the Federation of Young Democrats — Hungarian Civic Party. The new Hungarian Government, formed on the 8th of July, encourages in its program, civic organizations to undertake state responsibilities and promises them the necessary resources in order to provide public services. However, it is important to note that the Government’s program counts with massive economic growth and with growing funds available for a wide range of social sectors.

The new Government is planning to set up a separate division in the Prime Minister’s Office to coordinate the activities of the different ministries towards civil society. This division will also have the task of establishing best practices for contracting-out public services and initiating legislation for a more supportive legal environment. There are two areas where the Government really needs to count on PBOs. One is the pressing reform of the health-care system, and the other is the preservation and revival of cultural heritage, an area that will be taken care of by a separate ministry in the future.

Concerning the health-care system the Government intends to maintain it under the principle of universal insurance, based on solidarity, but it also aims to provide more opportunities to private and community initiatives. The program encourages the establishment of contribution-based supplementary health-insurance organizations. In all fields of the health-care services the Government is determined to assert a regulated market mechanism, which offers equal opportunities to the different sectors, i.e. state agencies, business companies and PBOs.

The Government intends to realize a cultural policy that helps the creativity of artists and encourages art patronage. Tax preferences on pledges for public purposes will be extended. Government measures will be taken to inspire both state agencies and private organizations to spend a certain percentage of their annual budget or income on cultural products and services. In addition to the existing National Cultural Fund, the Government is planning to establish a new source for cultural financing, the National Heritage Fund, which will be financed by the tourism industry.

Note

Daniel Csanády is a Managing Director of Extension Communication and an editor of Rule of Law Review (‘Jogállam’) in Budapest. He was previously a Public Policy Advisor in the Hungarian Parliament.

Kiss János altb. u. 24/C
Budapest 1126 Hungary
Tel./Fax: (36-1) 356-4695
E-mail: dcsanady@c3.hu