THE TERMINATION OF THE TREATY ON THE AVOIDANCE OF DOUBLE TAXATION BETWEEN THE UNITED STATES OF AMERICA AND HUNGARY, AS WELL AS THE PRIMARY TAX IMPLICATIONS
The United States of America and Hungary signed the Treaty on the Avoidance of Double Taxation (hereinafter: the "Tax Treaty") in 1979. On July 8, 2022, the U.S. unilaterally terminated the Tax Treaty and informed the Hungarian government of the termination through diplomatic channels. The termination took effect on January 8, 2023, because Article 26 of the Tax Treaty requires the terminating party to notify the terminated party at least six (6) months before the termination date, which was July 8, 2022. The Tax Treaty is still in effect until December 31, 2023.
To comprehend the Tax Treaty's benefits, examine the respective tax regulations of the contracting states and analyze how they will change after January 1, 2024, in the absence of the Tax Treaty, our office prepared the below summary.
Tax Liabilities of Companies
According to the Tax Treaty, a company's revenue is taxable only in the State where it conducts business. Furthermore, if the company operates business through a permanent establishment in the other State, the revenue of the permanent establishment is taxed only in the other State. In the absence of the Tax Treaty, the revenue of a company incorporated in Hungary that conducts business through a permanent establishment in the U.S. is not exempt from Hungarian corporate tax, but 90% of the tax paid in the U.S. counts toward the corporate tax assessed in Hungary.
Without the Tax Treaty, Hungarian companies that receive dividend distributions, interests, and royalties in the U.S. will be subject to 30% U.S. withholding source tax, a significant increase from the 0%-15% tax rate provided by the Tax Treaty, even though 90% of the tax paid in the U.S. will count toward the corporate tax assessed in Hungary.
The absence of the Tax Treaty will be less detrimental to U.S. companies because Hungary does not impose a withholding source tax, and dividend distributions, interests, and royalties generated in Hungary will not be assessed on U.S. companies in Hungary.
Tax Liabilities of Private Individuals
Dividends distributed to U.S. residents by Hungarian-based companies will be subject to a 15% withholding tax in Hungary beginning January 1, 2024, which is a minor change given current Hungarian tax regulations.
In 2024, a Hungarian resident or U.S. citizen permanently residing in Hungary who receives dividend distribution or other earnings will be required to pay 5% Hungarian personal income tax and 30% U.S. source tax. This means that private individuals with these types of revenues should face a 20% tax increase instead of the 15% withholding tax levied by the U.S. under the Tax Treaty.
Following January 1, 2024, interest income received from the U.S. will be classified as 'other income' in Hungary. The recipient will have to pay a 13% social contribution tax and the 30% U.S. withholding tax. Dividends and distributions from U.S. securities will be taxed similarly. U.S. residents' interest and royalties earned in Hungary will be subject to a 15% Hungarian source tax, which did not exist under the Tax Treaty.
Income earned by Hungarian citizens permanently residing in the U.S. may be subject to Hungarian taxation in the future, which means that in the absence of the Tax Treaty, the 'offsetting' method provided by the Hungarian tax rules will not automatically apply because the tax payable in both States will significantly increase.