Over the past year, we have read numerous tax industry news reports and analyses about the fact that the United States of America terminated its double taxation treaty with Hungary in the summer of 2022. The consequences of terminating the agreement will be fully realized from 2024, and the impact of the absence of the agreement on tax relations will take effect from that date. Our article hereby presents the current tax environment and the challenges we have faced.
On July 8, 2022, the U.S. Government notified to terminate the USA-Hungary tax treaty. The termination occurred 6 months after diplomatic notification of it, on January 8, 2023. According to the treaty, the USA-Hungary tax treaty expires from the year after the expiry of the 6-month period, i.e. January 8, 2023; it does not apply from 2024. Therefore, from 2024 there is no tax treaty applicable between Hungary and the U.S. in bilateral tax relations, resulting in higher withholding tax, and no treaty benefits.
Given that the creation of a new tax treaty is a lengthy process lasting years and it is uncertain when a new treaty can be concluded between the two states, it is essential to prepare for a situation without a treaty. So, let's turn to some specific tax consequences, which includes permanent establishment issues, sale of real estate holding companies and exchange of information.
Employees/Contractors in Hungary: Permanent Establishment
Tax treaties govern which state can tax the income streams involving two states, depending on the title of payment. If there is an agreement between two states, it overrides domestic tax rules and results in a more favorable situation for cross-border transactions. In the absence of a convention, the states concerned shall apply their domestic rules for taxation. In this case, the same income may be taxed by the provisions of two states at the same time, and any double taxation can be avoided only in the manner provided for in the domestic rules of the states.
In corporate income taxation, definition of 'permanent establishment' has particular importance if two or more countries are concerned, since it may trigger taxation right of a country on the profit of a company registered in another country. According to domestic Hungarian tax rules a foreign entity has a 'place of business' in Hungary (amongst others) if the following statement is fulfilled: "supply of services through a natural person employed by the foreign entity or performing the same activity in another legal relationship, provided that the supply of services exceeds 183 consecutive or intermittent periods in any twelve-month period".
According to the above, activities of people working for a US Company in Hungary should be analysed to avoid permanent establishment of the US Company in Hungary, still in cases where there is no office in Hungary. Based on the above wording of the Hungarian Corporate Income Tax Act, if a US Company provides services to its customers through staff working in Hungary for more than 183 days in a year, the US Company will be seen to have permanent establishment in Hungary for Hungarian corporate income tax purposes. This will result Hungarian CIT liability (i.e. the US Company will be subject to registration, CIT payment and tax return filing obligation on the income derived from its Hungarian activities).
Although this Hungarian rule is not totally new, so far the treaty rules overrode the domestic Hungarian tax rules and resulted in a more favorable situation for cross-border transactions, because the former US-Hungary treaty did not have such a rule and thus, the above was not applicable. This has changed as of 2024, therefore, it is strongly recommended for US Companies having employees/contractors in Hungary to review their employment/contractual structure to avoid permanent establishment issues and corporate income tax obligations in Hungary.
Real Estate Holding Companies
An issue like the above-mentioned permanent establishment issue can also arise in case of sale of companies having real estates located in Hungary.
According to the domestic Hungarian tax rules, a foreign person can be subject to Hungarian corporate or personal income tax, if he receives income by sale of shares in a company which owns immovable property located in Hungary.
According to this rule, if a US person sells his interest in a company which owns real estate in Hungary, the income from this transaction is taxable in Hungary. This results Hungarian tax liability, including registration, payment, and tax return filing obligations.
So far the treaty rules overrode the domestic Hungarian tax rules and resulted in a more favorable situation for similar cross-border transactions, because the former USA-Hungary tax treaty did not allow the taxation of such income; according to the treaty this income was taxable in the US.
This has changed as of 2024. Therefore, it is strongly recommended for US persons having companies with properties located in Hungary to review their structure to avoid any tax issues in Hungary. However, there are also several tax optimization opportunities available which could be considered.
Tax Information Exchange
In addition to double taxation treaties, the two states have other bilateral tax treaties that regulate certain forms of tax information exchange. Two such agreements have been concluded over the past decade between Hungary and the United States: the so-called FATCA Agreement on the Exchange of Financial Account Information, and the Agreement on the Exchange of Country Reports.
The terminated USA-Hungary tax treaty formed the legal basis for these two agreements, so its termination would have led to the termination of the information exchange agreements. At the same time, the shutdown of tax information exchange between the two states could have had serious consequences, raising the risk that without transfer of information all US-sourced payments to Hungarian financial institutions would be subject to a 30 percent withholding tax in the United States.
Since exchange of information also serves the interests of both states, as it helps to detect tax evasion by US residents, consultations took place between the two states from the second half of 2022 to ensure the continued functioning of these conventions. As there is an additional agreement between the two states allowing for the exchange of tax information, the smooth continuation of the exchange of information could be ensured. Back in the 1980s, the OECD and the Council of Europe jointly drafted a multilateral agreement allowing tax authorities to cooperate, and both Hungary and the United States are signatories to this multilateral convention, so this is what the USA-Hungary tax treaties in question may point to.
Regarding the FATCA Agreement, Hungary and the US signed a Memorandum of Understanding to consider the above-mentioned OECD Convention as the new legal basis for the exchange of information, so that reporting of account information and tax information exchange between authorities will continue unabated. Information on the signing of the Memorandum of Understanding was published on the website of the Hungarian Tax Authority on 19 December 2022. The competent authorities of the two states also signed a Joint Statement, according to which the Agreement on the Exchange of Country Reports is temporarily continued between the two states based on the OECD multilateral agreement.
It is evident that the exchange of information between the two tax authorities continues to persist. Therefore, taxpayers should assume that both tax authorities will have access to data regarding their income streams. Any tax advantages gained from the processing of tax information are only temporary. Thus, the saying applies here as well: "In this world nothing can be said to be certain, except death and taxes" as Benjamin Franklin stated.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.