Increased tax burdens for US and Hungarian taxpayers
The Budapest Business Journal interviewed some of Hungary’s leading experts on the possible economic effects of terminating the double taxation agreement between the United States and Hungary. In this article, Judit Kresz, Senior Partner at CMS, analyzes the potential consequences for US and Hungarian taxpayers and businesses.
If the double tax treaty between Hungary and the United States is indeed abolished from January 2024, this could potentially lead to increased tax burdens and administrative difficulties for American and Hungarian taxpayers.
For US investors in Hungary, the taxation of dividends, interest and royalties could change, but the effects would not be the same for businesses and individuals.
US retail investors can benefit from a 5% withholding tax on dividends if they own at least 10% of the shares of a Hungarian company that pays dividends. If the double tax treaty were terminated, they would be subject to Hungarian general personal income tax of 15% on such dividends. Under the treaty, interest and royalties can only be taxed in the individual’s country of residence and are therefore exempt from tax in Hungary. At the end of the treaty, a Hungarian personal income tax of 15% would have to be paid on these types of income. If, at the same time, an individual was also subject to tax on their Hungarian-sourced dividend, interest and royalty income in the US, a credit for the Hungarian tax paid may be possible under US rules. .
The taxation of dividends paid from Hungary to US private investors remains tax exempt as long as there is no withholding tax in Hungary under domestic rules, and the same applies to interest and royalties. However, if the Hungarian government were to introduce withholding taxes on these types of longer-term income, no reduction would be possible without a double tax treaty. Hungarian tax paid may be deducted from US tax payable by the corporate investor on the same income.
In the absence of a double taxation treaty, a US corporate investor who owns shares in a real estate-rich Hungarian company would fall under Hungarian corporate tax with respect to the capital gain realized on the sale of these actions.
In addition, less significant (but in some cases more important) changes could be that the allocation of income and costs between a US head office and its Hungarian branch would have to be done on the basis of Hungarian law, which could lead to a stricter approach than allocation based on double tax treaty rules. Another unpleasant consequence could affect US companies engaged in construction projects in Hungary, where a permanent establishment would have to be established after just three months instead of the current 24 months under the double tax treaty.
Nevertheless, the termination of the double tax treaty would affect American investors in Hungary less than Hungarian investors in the United States. Hungarian companies and individuals investing and earning income in the United States would face an increased tax burden due to high US withholding taxes (30% on dividends distributed by a US company). Absent a double tax treaty, Hungarian investors would not be able to reduce the US withholding tax rate or exempt US taxed income from Hungarian tax. Only US tax paid could be credited within certain limits according to national rules.
The absence 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 life more difficult for American and Hungarian investors, because asserting their rights could become much more hard. Other international tax agreements only partially offer similar provisions for the exchange of communications and information between the parties.
Overall, termination of the double tax treaty would mean that US-Hungarian tax relations would fall to the level that Hungary has with less developed regions of the world. Over the past decade, Hungary has worked hard to build an extensive treaty network that makes international investment more efficient. If the treaty with the United States (as Hungary’s second largest investor) were to disappear from the list, it would significantly weaken Hungary’s position in the international tax arena and undermine bilateral economic relations.
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