The Government of the United States has sent a formal notification to Hungary to terminate the effective tax treaty on the avoidance of double taxation between the two countries on the 8th of July. The provisions of the Tax Convention will cease to apply from 1 January 2024.
Tax treaties determine to what extent the participating countries are entitled to tax the income and provide the elimination of double taxation and a mutual agreement procedure to avoid tax disputes between the two countries. The U.S.-Hungarian treaty has been in effect since 1979. It would have been replaced by a renegotiated agreement that was completed by 2010, however, it did not enter into force due to a lack of U.S. ratification.
Based on statements from the US Treasury Department, the reason for the termination is that the Government of Hungary has vetoed the implementation of the 15% global minimum tax which is supported by nearly 140 countries (including the U.S.), with the aim of retaining the 9% Hungarian corporate income tax rate.
What does exactly the termination of the double tax treaty mean? The main consequences are the following.
1. Income of the private individuals
a, Private income (dividend, interest, capital gain)
Currently, dividend income can be taxed in both countries, but the dividend paying country’s tax rights are capped and can withhold only 15% withholding tax (or 5% withholding tax if the beneficial owner is a company which owns, directly or indirectly, at least 10 percent of the voting stock of the dividend paying company). The withhold tax in the US can be credited against the Hungarian personal income tax liability in which case additional personal income tax paying obligation in Hungary does not occur. If the tax treaty remains terminated, dividend income from Us source can be taxed in the US in line with the US tax rates. The Hungarian Personal Income Tax Act allows the credit of the foreign tax, however, the payable personal income tax in Hungary cannot be lower than 5% of the income.
Interest income and capital gain are taxable in the State where the receiving party is a tax resident based on the tax treaty. Therefore, in case a Hungarian tax resident have interest or capital gain from the US, 15% personal income tax paying obligation occur in Hungary and no tax is withhold in the US. Due to the termination of the tax treaty, the US may tax the interest income and the capital gain in line with the domestic regulation.
The interest income from Hungarian PIT perspective will be considered as other income and as such 90% of the foreign withhold tax can reduce the 15% personal income tax paying obligation in Hungary and 13% additional social contribution tax paying obligation occur in this relates.
In case of capital gains, the income could not be considered as income from a controlled capital market transaction and as such additional 13% social contribution tax may arise in Hungary (up to a ceiling of twenty-four times the minimum wage). The Hungarian Personal Income Tax Act allows the credit of the foreign tax, however, the payable personal income tax in Hungary cannot be lower than 5% of the income in this case.
b, Income from dependent activity
There are Hungarian tax residents who work in the territory of Hungary and the US as multistate workers or in the framework of assignment. With the termination of the treaty, Hungarian tax resident working in the United States will be taxed in the US in line with the US domestic rules. The tax treaty allowed some exemption from the US taxation (e.g. if the US stay did not exceed 183 days in a tax year) which will not be applicable and the US has the right to tax the income from dependent activity from the first day of the US work. 90% of the foreign withhold tax can be credited against the Hungarian personal income tax up to 15% of the taxable income.
2. Income of the entities
In the lack of the provisions of the 1979 tax treaty, Hungarian companies' income from the United States will bear a U.S. tax burden instead of the current 0% for interest and royalties, and 15% for dividends (or 5% in a special case).
A significant additional tax burden on U.S. companies' investments in Hungary is not expected in the absence of the tax treaty, as Hungary does not currently impose a withholding tax on payments to companies (including dividends, interest, and royalties).
Fortunately, both Hungarian and U.S. domestic tax rules contain certain relief mechanisms. According to the rules of the Hungarian Corporate Income Tax Act, 90% of the tax paid abroad can be deducted from the corporate income tax payable in Hungary (e.g. in case the Hungarian entity has a US permanent establishment).
The provisions of the U.S.-Hungarian Tax Treaty will remain in effect until the 31 December 2023. In the meantime, the 1979 treaty could be replaced with a new agreement, and revoking the termination is possible (e.g. in the case of support of the global minimum tax in Hungary). Based on the above, we can conclude that the termination of the tax treaty between Hungary and the US will have an effect to the incomes originated from Hungary or the US of individuals who are tax resident of one of the countries. BDO Hungary Tax Advisory Ltd. is at your service for providing tax advisory related to this topic.