On 8 July, the rather bad news that the U.S. Treasury Department is terminating the double taxation treaty concluded with Hungary in 1979 came like a bolt of lightning. The decision is believed to be based on the fact that Hungary vetoed the introduction of the 15 percent global minimum tax at the Ecofin Council meeting, i.e. at the meeting of the EU finance ministers held in Luxembourg. The termination – if the Hungarian government fails to reverse the American decision – would take effect from 2024.
Tax treaties are bilateral agreements defining mutually accepted tax rules for international transactions. They ensure that the contracting parties interpret certain terms in the same way (for example: what is meant by dividends or interest) and determine to what extent the countries signing the agreement – the country of residence and the country of the source of the income – are entitled to tax the income. In addition, they provide a method for the elimination of double taxation and a mutual agreement procedure to avoid disputes between the two countries. Hungary has concluded tax treaties with more than 80 countries, including EU member states, the USA, Australia, and Canada; the extensive convention system was considered one of the country’s most important attractions from a tax point of view.
As for the US/Hungary tax treaty, the parties actually concluded two treaties: the one of 1979, which is still in force, and the one of 2010, which has not yet been ratified by the United States Senate and thus has not entered into force. The termination would affect the 1979 convention, it would cease to be applicable from January 2024 at the earliest. Or more precisely: from the first day of January following the 6th month after the notice of termination given through diplomatic channels – which could therefore only be 1 January 2024 at the earliest. In respect of withholding taxes, this means that the provisions of the tax convention can no longer be applied to amounts (interest, dividends, royalties) paid or credited on or after the first day of January next following the expiration of the 6-months’ period; in respect of other taxes, it will no longer apply to taxable periods beginning on or after the first day of January next following the expiration of the 6-months’ period.
But what does this mean exactly? In short: the tax effects of each international transaction will have to be established in parallel according to the domestic laws of both contracting states. The tax obligations of Hungarian tax residents will be basically governed by the rules of the Hungarian corporate income tax and personal income tax acts, while the tax obligations of U.S. tax residents will be governed by the rules of U.S. federal taxation. In case the taxation according to domestic laws would lead to double taxation, it will be possible to mitigate or avoid this according to the domestic rules regarding the avoidance of double taxation.
Fortunately, both Hungarian and U.S. domestic tax rules contain such so-called relief mechanisms. Without going into detail, it can be said in broad terms that according to the rules of the Hungarian Act on Corporate Income Tax, 90% of the tax paid abroad, up to a maximum of the tax calculated with the average tax rate applicable to the given company, can be deducted from the corporate income tax payable; the personal income tax payable regarding the consolidated tax base of individuals (i.e. regarding the majority of income types) in Hungary can be reduced by 90% of the tax paid abroad, but by no more than a 15% tax calculated on foreign income. In the case of separately taxable income types (for example, capital income), the tax paid abroad can also be credited, but a tax corresponding to 5% of the tax base must still be paid to the Hungarian tax authority.
The federal taxation rules of the United States also eliminate double taxation for US taxpayers by applying the Foreign Tax Credit (FTC) and tax deduction rules.
Hungary does not impose withholding tax, and the domestic 9% (corporate tax) and 15% (personal income tax) rates are significantly lower than the US federal tax rates, so American investors will probably be less adversely affected by the lack of a tax treaty. On the other hand, the USA imposes a high, 30% withholding tax on foreign taxpayers, and in addition, the withholding tax is not only charged on capital income, but also on service fee income. Consequently, an increased tax burden can be expected by Hungarian businesses and individuals realizing income from the USA.
The lack of an agreement can also be unpleasant in possible interpretation disputes. In the absence of a uniform definition and a mutual agreement mechanism, persons with both American and Hungarian income may encounter difficulties when determining their tax obligations.
It may perhaps give some hope that the two states still have 1.5 years to smooth out their differences before the convention finally ceases to have effect. However, taking into account the fact that the terminated US/Hungary treaty is/was an extremely advantageous agreement for Hungary, even in international comparison, which the USA probably does not want to re-enact, and that the negotiation and ratification of a new agreement is a rather lengthy legal process, no matter how effective the negotiating delegations are, it is almost certain that even if there is a new agreement, it will not be able to enter into force immediately after the expiration of the current agreement. Furthermore, we would like to draw your attention to the fact that the totalization agreement on social security between the United States of America and Hungary remains in force, so the coordination regarding social security contribution obligations and benefits between the US and Hungary is ensured for the time being.