Increased tax burdens for U.S., Hungarian taxpayers

If the double-tax treaty between Hungary and the United States really is abolished from January 2024, it could potentially lead to increased tax burdens and administrative difficulties for both U.S. and Hungarian taxpayers.

For U.S. investors in Hungary, taxation of dividends, interests, and royalties could change, but the effects would not be the same for corporate and private individual investors.

Private individual U.S. investors can benefit from a 5% withholding tax on dividends if they own at least a 10% share in a Hungarian company that pays dividends. If the double-tax treaty was terminated, they would be subject to the general 15% Hungarian personal income tax on those dividends. Under the treaty, interest and royalties can only be taxed in the private individual’s country of residence, so are thus tax-free in Hungary. On the termination of the treaty, Hungarian 15% personal income tax would have to be paid on these types of income. If in parallel a private individual was also subject to taxation on his/her Hungarian sourced dividend, interest, and royalty income in the United States, credit for the Hungarian tax paid may be possible according to U.S. rules.

The taxation of dividends paid from Hungary to U.S. corporate investors remains tax-free as long as there is no withholding tax in Hungary under domestic rules, and the same applies to interests and royalties as well. However, should the Hungarian government introduce withholding taxes on these types of income in the longer run, no reduction would be possible without a double-tax treaty. Hungarian tax paid may be credited against the U.S. tax payable by the corporate investor on the same income.

In the absence of a double-tax treaty, a U.S. corporate investor that holds shares in a real estate rich Hungarian company would fall under Hungarian corporate taxation regarding the capital gain realized on the sale of such shares.

Further, less significant (but in some cases more important) changes could be that the income and cost allocation between a U.S. headquarters and its Hungarian branch would have to be carried out based on Hungarian legislation that may lead to a stricter approach than the allocation based on the double-tax treaty rules. Another unpleasant consequence could affect US businesses engaged in construction projects in Hungary, where a permanent establishment would have to be created after only three months instead of the current 24 months under the double-tax treaty.

Nevertheless, the termination of the double-tax treaty would affect U.S. investors in Hungary less than Hungarian investors in the United States. Hungarian businesses and individuals investing in and realizing income from the U.S. would have to endure an increased tax burden due to the high withholding taxes in the US (30% on dividend distributed by a U.S. company). In the absence of a double-tax treaty, Hungarian investors would not be able to reduce the U.S. withholding tax rate or exempt U.S. taxed income from Hungarian taxation. Only the U.S. tax paid could be credited up to certain limits according to domestic rules.

The lack of provisions on the mutual agreement mechanism and the end of the exchange of information between the two countries in cross-border situations would make the lives of both U.S. and Hungarian investors more burdensome, as enforcing their rights could become much more difficult. Other international agreements in taxation matters only partly offer similar provisions for the exchange of communication and information between parties.

Overall, the termination of the double-tax treaty would mean that U.S.-Hungarian relations in tax matters would fall to the level that Hungary has with less-developed parts of the world. In the last decade, Hungary has worked hard to build a wide treaty network that makes international investments more efficient. If the treaty with the United States (as Hungary’s second largest investor) were to disappear from the list, this would significantly weaken Hungary’s position in the international tax arena and would undermine bilateral economic relations.