For more than 10 years, tax professionals have kept a close eye on developments concerning the US-Hungary treaty on the avoidance of double taxation (hereinafter: US-Hungary Treaty), which reached a new turning point in 2022.

The termination of the US-Hungary Treaty

The treaty, signed and promulgated in 1979, is one of the oldest such conventions of Hungary, so it is no wonder that negotiations on a new treaty have been under way since the early 2000s to adapt to the changed economic and tax environment. The new treaty was promulgated in Hungary in 2010, but not in the United States, which also means that this new treaty is not yet applicable, and therefore the 1979 document remains the basis for tax matters. At least for a little longer, given that on 8 July 2022 the United States has indicated through diplomatic channels that it will terminate the tax treaty currently in force. After that date, the US-Hungary Treaty remained in force for another 6 months, and then expired on 8 January 2023, which means that – under the transitional rules – it will no longer apply in tax relations from 2024.

International tax treaties override domestic rules, preventing double taxation and generally providing more favourable and simpler rules for taxpayers. The termination of the US-Hungary treaty therefore also means that income from the US and Hungary may now be directly subject to the rules of both countries. In this article, we aim to summarise the most important changes regarding the taxation of income from both the US and Hungary.

Withholding tax may be a new tax burden

For both individuals and corporations, a new tax burden could be withholding tax (i.e. the tax levied by the state where the income is earned), which until 2023 was only applicable to dividends, capped at 5% and 15%. From 2024, however, Hungarian taxpayers will have to calculate with an additional tax burden of 30% on payments from the US. Under the current rules, withholding tax in Hungary in relation to the United States can only arise in case of individuals, when a payment is made to an individual who is resident in the USA.

This also means that Hungarian beneficial owners will also be subject to US tax on their various capital gains (dividends, interest, capital gains), whereas previously they did not have to pay such tax.

The obligation to pay social contribution tax may also arise

In case of interest and the sale of real estate, additional tax liability may also arise due to the reclassification of income because, in the absence of a treaty, these are considered as “other income”, and are thus subject to a 13% social contribution tax, also above the taxable income threshold. However, based on the draft version of the Autumn Tax Bill for 2023 a change is expected in this: if the bill is passed, interest paid by OECD resident companies and income from securities issued by such companies will be exempt from reclassification and will only be subject to the taxable income threshold.

Additional personal income tax and social contribution tax liability may also arise in connection with stock exchange transactions because, if a US resident investment service provider is used, the favourable rules for controlled capital market transactions (such as the possibility of tax equalisation and the exemption from social contribution tax) will not apply in the future and will therefore be subject to 15% personal income tax and 13% social contribution tax, the latter up to the taxable income threshold.

Amended rules of tax residence

From 2024, companies may also want to look more closely at the rules on tax residence, especially if they are involved in construction in another state or carry out their activities with the help of employees working in another state:

• In the former case, a US resident company will be considered to have a permanent establishment in Hungary after 3 months instead of the current 24 months.
• In the latter case, the service establishment rules introduced in Hungarian law in 2021 will apply (where services are provided through an employee employed in Hungary for more than 183 days in a 12-month period). So far, this has only appeared in a small number of cases, given that only a small number of treaties contain a provision on this issue, and such an activity giving rise to a service establishment was not mentioned in the US-Hungary treaty either.

However, in the absence of a treaty, the above should be taken into account when making the permanent establishment analysis, which may result in a number of US resident companies incurring corporate tax liabilities in Hungary.

Taxation of a company owning real estate property

US resident investors may in the future be subject to corporate income tax on their shares in a real estate company (where the value of the domestic real estate exceeds 75% of the book value of the assets at the balance sheet date of the company, either individually or together with its affiliates that are foreign entities) if they realise a foreign exchange gain on their shares in such a company. This has not been allowed under the US-Hungary treaty, but its repeal has opened the way for such taxation of US taxpayers in Hungary.

The tax liability of posted workers

We should not forget about the newly arising tax liabilities of posted workers either. In the absence of a US-Hungary tax treaty, the exemption rules previously granted by the treaty do not apply, and work performed in the other country is taxable from day one. For example, a US individual posted from a US resident parent company to a Hungarian subsidiary to provide training becomes liable to pay income tax in Hungary on the pro rata share of his or her salary. In the case of a longer-term posting, the possibility of Hungarian tax residence may also arise, which may then result in the posted worker being subject to tax in Hungary on all of his/her worldwide income.

Avoiding double taxation

Under the internal rules, both companies and individuals can benefit from the possibility to offset foreign tax, but this will result in a higher tax liability from 2024 than under the previous, typically exemption rules.

There are, however, limitations to the offsetting on several levels; for example, only up to 90% of the tax paid in the US can be used to reduce the Hungarian tax liability. But this is not the only limitation, The value of the deductible tax cannot exceed the tax assessed on the income in question in Hungary, i.e. it cannot be used to reduce tax liability on other types of income.

Individuals must also take into account two further conditions:

• only non-resident (i.e. non-Hungarian-source) income is eligible for the offset, and
• a tax liability of 5% is payable in any case on separately taxable income.

This means that in the case of HUF 1,000,000 of dividend income from the United States, the full amount of the withholding tax deducted at source, corresponding to HUF 300,000, cannot be offset against the HUF 150,000 Hungarian tax, only up to HUF 100,000, subject to the 5% tax payable in Hungary. For an individual, this would result in a HUF 350,000 tax liability, which is HUF 250,000 higher than the previous HUF 150,000 tax burden.

Areas not affected by the termination of the treaty

It is important to note that Hungary’s social security treaty with the United States and the data exchange agreements will remain in place, so the resulting benefits will also continue to apply.

In order to ensure that these changes do not come as unexpected for those affected, in all cases where the US and Hungary are involved in the generation of income, we recommend that you start analysing the situation in time to determine your tax liabilities, and our tax experts are at your disposal.