The termination of the tax agreement will have serious consequences for American and Hungarian companies

On July 8, the Hungarian government received a formal notice from the US government terminating the current tax treaty between the two countries. The treaty mainly aims to regulate various issues related to taxation and in particular to avoid double taxation for taxpayers with interests in both countries.

It is possible that the United States wants to put pressure on Hungary to block the introduction of the global minimum tax instead of cutting economic relations between the two countries. This can be deduced from the fact that the formal notice was issued after June 30 and therefore the termination will be effective from 2024. Until 2024, there is a chance that the two countries can settle the situation even in replacing the current tax treaty. The current tax treaty was already obsolete and both parties agreed to introduce a new treaty in the early 2000s, however, for political reasons the United States did not ratify the new treaty.

Petra Rozsahegyi

The United States is one of Hungary’s most important trading partners and therefore the termination of the tax treaty can and will have negative consequences on many aspects of the US-Hungarian relationship. To name just a few of the more obvious and significant consequences, the following aspects of business life could be affected:

• The rate of US withholding tax levied on dividends and interest paid by US payers to Hungarian payees will increase significantly to an amount that cannot be deducted from the Hungarian payee’s tax base. Accordingly, investments in the United States by Hungarian companies or investments through a Hungarian company may no longer be feasible or profitable. As Hungary does not currently levy withholding tax on outgoing dividends or interest payments, there will be no immediate change for these flows, but this may change in the future if Hungary decides to follow the American model and would levy a withholding tax on outgoing dividends or interest. .
• In financing industry transactions (in the case of financing arrangements, credit facilities, etc.), the parties usually include gross-up clauses in their agreements, i.e. the obligor is obligated to pay more to the creditor if withholding tax has to be deducted from the payment in the debtor’s country. Such clauses, however, generally only protect the creditor if the borrower is in a signatory country. At the end of the tax treaty, Hungarian and US creditors may find that they are no longer protected from withholding tax in the other country.
• The income of American expatriates employed by a Hungarian company could be subject to increased (double) taxation, i.e. they will not be able to take advantage of the treaty to avoid double taxation. To compensate for the increased tax burden, employers may need to increase the salary or otherwise change the employee’s package, which increases labor costs.
• Special arrangements between companies in the United States and Hungary may also suffer since the tax treaty (along with judicial and professional analysis of tax treaties) has also provided a conceptual framework for interpreting structures and transactions. The loss of this framework will make it much more difficult to assess the tax consequences and therefore the costs of such arrangements.

In addition to the direct tax consequences, this change may have serious implications for the general trade relationship between the United States and Hungary. Loss of treaty means loss of predictability of an important cost aspect on an investment. Such increased risk will show up in business plans and projections and may reduce the attractions of cross-border investment and transactions between the two countries.