Possible effects of the termination of the U.S.-HUN tax deal
The Budapest Business Journal asked some of Hungary's foremost experts about the possible economic effects of the termination of the U.S.-Hungary double taxation agreement. In this article, Zoltán Horváth, tax manager at VGD Hungary, explains his views on the issue.
On July 8, 2022, the United States notified Hungary that it would unilaterally terminate the 1979 double tax treaty between the two countries.
Due to the timing of the termination the existing convention will be still in force until 2024, which means that the consideration of the possible tax and economical consequences is merely hypothetical at this stage. However, it is interesting to see what would happen if the tax treaty between the two countries were to be abolished.
Considering that the tax treaty settles plenty of tax issues, the absence of the treaty would cause a series of legal uncertainties, furthermore, may result in the disruption of the economic relations between the two countries and Hungary's reduced ability to attract capital (i.e. the number of U.S. holding companies in Hungary will fall).
Above all, the termination of the convention could lead to:
- an extension of the right to levy withholding taxes on both sides,
- the change of the legal titles of certain incomes (i.e. interest shall be considered as other income from personal income tax perspective etc.) resulting in higher tax liability, and
- stricter rules regarding permanent establishments and tax residency,
which could affect badly investors and cross-border activities in both countries.
Just to mention some negative impacts:
- both Hungarian individuals and companies should pay a 30% withholding tax on dividend, interest and royalty incomes in the absence of the treaty. In the case of companies the U.S. tax would be offset against the Hungarian tax liability to a certain extent (90%), however private individuals have to pay 5% Hungarian personal income tax in addition.
Currently, Hungary does not impose withholding tax on dividends, interests and royalties paid out to U.S. investing companies, however, in the absence of the treaty, Hungary will be entitled to introduce unilaterally withholding tax on these types of payments.
Furthermore – beyond dividends - the interest and royalties paid out to U.S. private individuals would be subject to 15% PIT in Hungary.
- in the absence of the treaty Hungarian private individuals will be obliged to pay higher taxes (28%) on interest income (which would qualify as other income) instead of the current 15%. Furthermore, the other income deriving from the transfer of real estates located in the United States performed by Hungarian private individuals would trigger 28 % Hungarian tax liability in general.
In these cases, the foreign and the domestic PIT liabilities could be offset against each other up to the 90% of the U.S. tax.
- private individuals involved in trading shares of U.S.-listed companies would have to pay more taxes (generally 28% instead of the current 15 %) in the future due to the change in legal title.
- in the lack of treaty, the wages paid out to (posted) employees will be subject primarily to the jurisdiction of the state where the employment is exercised independently from other circumstances, meanwhile, the country of residence would maintain also the right to levy tax on that income. However, the tax paid abroad can be offset against the actual tax liability to a certain extent (90%).
- the absence of the treaty will increase the number of cases in which the U.S. entities will have Hungarian fixed establishment under Hungarian CIT rules (e.g. construction works will trigger Hungarian PE after 3 months; in case of service provision in Hungary PE may arise etc.).
In the absence of the treaty, the U.S. permanent establishments of Hungarian companies will be subject to Hungarian CIT, however, the foreign tax can be deducted from the Hungarian tax liability in a limited way.
In the lack of the treaty, the rules related to real estate holdings might be applicable, which would trigger Hungarian tax liability (9%) for U.S. companies.
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