Hungarian firms investing in the U.S. to be more affected by lack of tax deal

The U.S. Treasury Department unexpectedly provided notice to Hungary on July 8 on terminating the U.S.-Hungary income tax treaty, which has been in effect since 1979. The provisions of the treaty are to remain in effect at least until 1 January 2024. After this date, the following consequences may arise, unless in the meantime a new income tax treaty is ratified by the parties, or the U.S. Treasury reverses its actions with respect to the 1979 tax treaty.

U.S.-owned companies operating in Hungary are not facing fundamental changes as a result of this potential measure, since - currently - Hungary does not levy withholding tax on Hungarian-sourced income paid to entities (including dividend, royalty, and interest payments). This means that no treaty reliance is required for the U.S. investor for a Hungarian withholding tax-free distribution, payment. A specific case is U.S. investors owning directly Hungarian land-rich companies, where the cancellation of the treaty may trigger unfavorable, though rather ring-fenced consequences. This is because now if a US company realizes gains from its direct investment in a Hungarian land-rich company, exemption from the 9% Hungarian tax is the result of the treaty provisions, which tax would otherwise apply (but typically could be credited against the tax payable in the United States).

The adverse effects of the treaty’s termination are more significant in the case of Hungarian companies investing in the United States. This is due to the fact that now, under the treaty, they enjoy a favorable U.S. withholding tax treatment, where the interests and royalties they receive is free from U.S. tax, and the dividend withholding tax is typically 5% only. These 0% and 5% tax rates will be replaced by a 30% US tax charge in the lack of an effective tax treaty.

In terms of the overall effect on the Hungarian economy, the exact consequences are hard to predict. However, let us not forget that (i) the Hungarian investments in the United States - which are affected by the termination - are potentially not that overwhelming on a national level, and (ii) the U.S. investments in Hungary - which are on the other hand are more significant - are not expected to suffer any significant direct loss even without an effective tax treaty.

Thus, although the termination of the tax convention is in fact a step backwards in the U.S.-Hungarian economic ties, and Hungary’s appearance in the eyes of foreign investors, probably the U.S. announcement results in no major hit on the Hungarian economy.