August 1, 2022

US Treasury issues notice to Hungary to formally withdraw from longstanding US-Hungary Income Tax Treaty

Robert Chase II, Kyle Colonna, Caroline Setliffe

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Eversheds Sutherland (US) LLP The US Treasury is moving to formally withdraw from the US-Hungary income tax treaty, which has been in effect since 1979 (the Treaty). For previous reporting by Eversheds Sutherland regarding the Treaty, see US-Hungary tax treaty hangs in balance.

• The Treaty does not include many of the provisions that are common in US international tax treaties today, including, notably, a comprehensive limitation on benefits provision.

• The withdrawal will take effect on January 8, 2023, effectively leaving the two countries without a comprehensive international tax treaty in effect beginning on January 1, 2024.

• Although an updated treaty between the countries was signed by the United States and Hungary in 2010, it has been awaiting ratification in the US Senate since then and there is no indication as to whether or when it may be advanced.

• In support of its decision to withdraw, the US Treasury cited to long-held concerns—which were presented by the US Treasury to Hungary in discussions held in the fall of 2021—regarding Hungary’s tax system and the Treaty itself, as well as the lack of satisfactory action taken by Hungary to address such concerns.

The Treaty, like other international tax treaties, provides double taxation relief to residents of the United States and Hungary. For example, under the Treaty, withholding taxes on dividends paid by US corporations to shareholders that are resident in Hungary generally are reduced from 30% to 15% of the gross amount of the dividend (and to 5% in the case of a company in which the shareholder owns a 10% or greater voting interest). And, under the Treaty, US source interest or royalties are exempt from US withholding tax, which otherwise would be imposed at a 30% rate.

Because Hungary generally does not impose withholding taxes on interest, dividends, or royalties, the elimination of these Treaty provisions is less significant to US investors in Hungary, but the loss of other Treaty benefits may be relevant.

To this end, the Treaty includes standard provisions relating to the taxation of “permanent establishments”, which restrict one country from taxing the business profits of the other country unless attributable to a “permanent establishment” (generally, a fixed place of business or a dependent agent) in the taxing jurisdiction. The US withdrawal from the Treaty means that these permanent establishment protections cease to exist for US taxpayers operating in Hungary, and for Hungarian taxpayers operating in the United States. Although Hungarian tax rates are lower than US tax rates (Hungary’s corporate tax rate is 9% and its individual income tax rate is 15%), the absence of permanent establishment benefits could mean that a single item of income is subject to tax in both the United States and Hungary, significantly increasing the effective tax rate on such income.

Eversheds Sutherland Observations: Article 26 of the Treaty provides that the Treaty can be terminated on six-months’ notice, and the required notice now has been given. In accordance with Article 26, termination will be effective on January 8, 2023. With respect to taxes withheld at the source, the Treaty ceases to have effect on January 1, 2024. In respect of other taxes, the Treaty ceases to have effect with respect to taxable periods beginning on or after January 1, 2024.

Assuming the six-month notice period continues to run without any revocation of the notice, the existing Treaty would generally cease to have effect in 2024. This gives taxpayers some time to address the potential impact of the elimination of the Treaty on their operations and activities in the United States and Hungary.

The US Treasury’s decision to move to terminate the Treaty coincides with Hungary’s recent decision to block the European Union’s (the EU’s) implementation of a global minimum tax in accord with Pillar Two of the OECD Inclusive Framework. Despite Hungary’s veto, the Pillar Two rules include a “top-up tax”, which would be applied where profits in any jurisdiction are subject to a rate below the minimum tax rate, determined on a jurisdictional basis. Hungary’s corporate tax rate is 9%, which is below the internationally agreed upon limit of 15%. Hungary is a member of the EU and under EU rules, changes to tax laws require unanimous agreement by all 27 member countries. If Hungary reverses its decision to block the global minimum tax, the US Treasury feasibly could move to withdraw its termination notice. Notably, the US Treasury withdrew its notice (in part) to terminate the US-Netherlands Antilles income tax treaty in 1987. Thus, a reversal of the termination would not be unprecedented. It also is conceivable that the Senate could move to ratify the treaty with Hungary signed in 2010, but to date there has been no indication from the Senate that they intend to move forward.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.