The U.S. government announced on July 2022, 8, that it was terminating the 1979 International Treaty for the Avoidance of Double Taxation with Hungary. If no agreement is reached between the two countries, the provisions of the convention currently in force will no longer apply from January 1, 2024.
Since the cancellation of the treaty last summer, there have been no news of any negotiations between the two governments regarding this issue. Furthermore, last week the Hungarian Tax Authority has published a notice about the effects of the cancellation of the U.S.-Hungarian double taxation treaty.
These mark an end to hopes that the treaty might be reinstated or a new treaty might be introduced. Starting from January 2024 there will be no treaty to prevent double taxation for U.S. and Hungarian tax residents. As a result, everyone concerned should prepare for life without the double taxation treaty as of January 2024 (the provisions of the expired agreement can still be applied until December 31, 2023).
We hereby present the potential consequences of the termination of the tax treaty and summarize what are the most important changes affecting individuals and companies.
WHAT IS THE U.S.-HUNGARIAN DOUBLE TAXATION TREATY ABOUT?
The double taxation treaty between the U.S. and Hungary first came into force in 1979. Primarily, it intended to define tax residency in the U.S. and in Hungary and encourage compliant tax payment by making it fairer and more straightforward. There was supposed to be an amendment in 2011, but it was never ratified by the U.S. Senate, so the original agreement remained.
This was always an agreement that was more favourable to Hungarian tax residents. This is because the U.S. imposes significant withholding taxes, which is not the case in Hungary. As a result, Hungarian tax residents who have income from the U.S. were spared being taxed twice, while benefits for U.S. tax residents were less obvious.
TAX RESIDENCY FOR INDIVIDUALS
If there is no double taxation treaty between Hungary and the USA, the circle of resident individuals will be expanded to include those who were previously considered non-residents solely because of the convention. Thus, from January 2024, not only Hungarian individuals living in Hungary may be subject to tax payment and reporting on their income from the United States, but also Hungarian citizens who have lived in the United States for years and do not receive income from Hungary (because Hungary defines tax residency status based on citizenship).
The termination of the convention also affects U.S. individuals who are not considered residents under the Hungarian rules but receive income from Hungary. In their case, all income from Hungary will be taxable according to Hungarian rules.
The most conspicuous change for U.S. natural persons with income from Hungary will be that they become subjects to the 15% Hungarian personal income tax. Starting from January 2024, income from short term gainful activity in Hungary (meaning for less than 183 days in a given fiscal year and this includes, for example, income from employment, income earned as a manager, income from self-employment, income from renting real estate, etc.) will not only be taxed in the U.S., but also in Hungary. However, up to 90% of the U.S. tax can be deducted from the Hungarian tax payable (some conditions apply).
In the case of separately taxable income (such as dividends, income from capital gains) received by Hungarian tax residents, the tax paid in the United States can be taken into account, however, a 5 percent tax must be paid in Hungary anyway. Furthermore, the beneficial tax treatment of controlled capital transactions (which results exemptions from social charges) will not be applicable to transactions carried out on U.S. capital markets.
WHAT ABOUT COMPANIES?
In the absence of an agreement, there is a significant difference between the U.S. and Hungary.
Hungary does not levy withholding tax, and the 9% corporate tax rate in Hungary is significantly lower than the U.S. tax rate. As a result, U.S. investors will be less adversely affected by the lack of a tax treaty since U.S. companies will not be subject to Hungarian withholding tax even in the absence of a tax treaty.
In contrast, the U.S. will impose a high withholding tax on foreign taxpayers, and the withholding tax will burden not only capital income but also revenues from the provision of services.
If your Hungarian business provides services to U.S. clients from a distance (e.g. IT solutions created at your office in Hungary), the place of service performance is likely not in the U.S. As a result, U.S. withholding taxes probably do not apply to them. However, in the absence of the agreement, some service income of Hungarian companies might still be subject to withholding tax in the United States.
Currently, under the convention, the U.S. is entitled to tax Hungarian companies on dividend income, where the tax rate is capped at 5% and 15%, depending on the shareholding rate. The convention does not allow the withholding of interest and royalty revenues, as it places the right of taxation in the country of residence, i.e. Hungary in the case of Hungarian companies.
However, in the absence of the agreement, capital income of Hungarian companies can be subject to a 30 percent withholding tax in the United States, which will thus represent the most significant change in the case of interest and royalty incomes, since until now the profits from these have been borne exclusively by the 9% (in some cases 4.5%) Hungarian tax.
On a positive note, in the absence of the agreement, 90 percent of the U.S. withholding tax will be included in the Hungarian corporate tax return, however, the offsetting cannot exceed the amount of the average tax on the given income, so no more than 9% can actually be taken into account.
GLOBAL MINIMUM TAX
Hungarian companies continue to be paying corporate tax at 9%, which is the lowest in the EU. Since last year, the Hungarian government agreed to participate in the Global Minimum Tax initiative, also to be implemented starting from 2024, but that affects only corporations with a worldwide yearly income above EUR 750 million. Small and middle-sized companies with a Hungarian registered seat and below that kind of revenue will continue to be taxed at 9% (in some cases at 4.5%) of their profits, without any need to top up their taxes to the otherwise required 15%.
HUNGARIAN PROPERTY AND ASSETS OF U.S. BUSINESSES
At the same time, if a U.S. company or its Hungarian subsidiary has real estate assets in Hungary, the U.S. company may become subject to Hungarian corporate tax when those assets are sold, whereas currently no such tax applies.
Companies must pay taxes in Hungary if the income earned by the company owning immovable property through the disposal or withdrawal of an existing shareholding, but only if the double taxation convention allows it. The current U.S.-Hungary agreement is of the old type, so it does not allow U.S. companies to tax their gains from immovable property in Hungary. In other words, if a U.S. company sells its share in a Hungarian real estate company, it does not have a Hungarian corporate tax effect within the meaning of the agreement.
However, this could change with the termination of the contract. Namely, if an American company holds a shareholding in a Hungarian subsidiary with significant Hungarian real estate assets, the American shareholder may be subject to Hungarian corporate tax at the time of disposal. All this would mean a 9 percent Hungarian corporate tax liability for the U.S. owner company in Hungary.
Furthermore, if a U.S. company has active premises in Hungary, that will also create Hungarian tax residency (permanent establishment) after 3 months (instead of the current 24 months): e.g. construction works or assembly activities carried out in Hungary currently grants Hungary the right to tax if there is a presence of more than 24 months, while in the absence of the convention, the rate specified in the local law will be relevant. Thus, for example, construction work carried out by an American company will in the future create a taxable permanent establishment in Hungary after 3 months.
Moreover, if a U.S. company provide services in Hungary (e.g. they send one of their employees to Hungary to work on a local project), 183 days of presence will make that a permanent establishment, creating tax liability, in contrast with the current situation, where tax liability does not necessarily apply. There are still many issues that need to be clarified in relation to the rules on services, which will be more relevant if the agreement is terminated.
The cancellation of the Double Tax Treaty might also create several issues for specific structures, like holding structures, group finance and IP structures, thus, the consequences of the cancellation of the double tax treaty should be carefully analysed in such cases.
CONSULT A TAX ADVISOR IN TIME
The cancellation of the U.S.-Hungarian double taxation treaty will affect U.S. investors active in Hungary. Consult a tax advisor on time to learn about any changes to the taxes you must pay starting from January 2024.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.