United States responds to Hungary’s global minimum tax veto

United States responds to Hungary’s global minimum tax veto

Tue 13 Sep 2022

On 8 July 2022, the US Treasury Department announced that it would unilaterally terminate its 1979 bilateral treaty with Hungary. The decision follows Hungary’s veto of an EU directive implementing a global minimum tax.

Contrary to expectations, Hungary did not support the adoption of the EU directive on a global minimum tax at the Economic and Financial Affairs Council (ECOFIN) meeting on 17 June. In response, the US government announced that it would terminate its international treaty with Hungary on the avoidance of double taxation. The timing of the termination is an attempt to put pressure on the Hungarian government, but, so far Hungary is sticking to its position.

In a statement, the US Treasury Department said that part of its decision is that the tax treaty unilaterally benefits Hungary as the US corporate tax rate is 21% and only 9% in Hungary. In response to the US announcement, the Hungarian Finance Minister said that the official tax policy and technical arguments given as the reasons to terminate the treaty do not reflect reality. Rather, the decision was because Hungary has vetoed the implementation of the global minimum tax rules agreed by 140 countries, the introduction of which would be in the US’s interests.

As things stand, unless the two countries reach an agreement, the treaty’s provisions will not apply after 1 January 2024. This will affect Hungarian businesses and individuals in several ways.

The impact of the termination of the treaty on companies

Under the current treaty, US-sourced income earned by Hungarian companies is subject to lower rates of US withholding tax. Currently, the tax rate on US-source dividend income is 5% to 15%, depending on the level of ownership. This means that a Hungarian company with a subsidiary in the US is only subject to a 5% withholding tax on dividends if the beneficial owner holds at least 10% of the voting capital of the company paying the dividend. In all other cases, the tax rate is 15%.

In addition, there is no US withholding tax on interest and royalty incomes, as it places the right of taxation in the country of residence, which in this case is Hungary. Currently, in the absence of a withholding tax, only the 9% corporate tax is levied on this type of income in Hungary.

However, in the absence of a treaty, the withholding tax rate will increase to 30%, which will apply not only to capital gains but also to income from the supply of services and, most significantly, interest and royalty income. In terms of interest and royalty income, while 90% of the US withholding tax will be deductible in Hungarian corporate tax, the deduction cannot exceed the average tax payable on the given income. So only 9% of the income, or less if the average tax rate is lower, can be taken into account.

On the other hand, US investors would be less adversely affected by the absence of a tax treaty, given that Hungary does not apply a withholding tax on dividends or interest income paid to foreign companies. Plus, the Hungarian corporate tax rate is lower than the US rate. Thus, the entire after-tax profits of a foreign company operating in Hungary could be paid to the US parent company.

Of course, Hungary would have the option of introducing a withholding tax. However, given Hungarian tax policy considerations, such a decision by the government is unlikely. The only adverse change that could affect US companies is if they divest or withdraw an existing shareholding in a subsidiary with real estate assets in Hungary. Under the treaty, the gain from the transaction would only be subject to US tax, but, without the treaty, the income would also be subject to the 9% Hungarian corporate tax. Although presumably, the Hungarian tax can be deducted from the US tax liability.

Expected changes for individuals

The current treaty rules provide that dividend income earned by a US-based Hungarian individual is subject to a 15% US withholding tax and is not subject to personal income tax in Hungary. In the absence of the treaty, a further 5% Hungarian tax liability will arise on top of the 30% US withholding tax, so a total of 35% income tax may be payable on an individual’s income. Currently, there is no US withholding tax on interest income, whereas in Hungary it is subject to 15% personal income tax. With the termination of the treaty, these incomes would also be subject to a 30% withholding tax in the US and will be considered as ‘other income’ in Hungary. This means that the 13% social contribution tax would also be payable, from which the amount of withholding tax already paid cannot be deducted.

For the time being, income earned by Hungarian individuals in the US from employment and renting out property is taxable only in the US. If the treaty were to be terminated, this income would also be subject to 15% Hungarian personal income tax. Of the tax paid in the US, 90% would be deductible, up to a maximum of 15% tax on income.

However, the termination of the treaty would also affect US individuals. Without the treaty’s provisions, Hungarian personal income tax will also be payable by individuals who are not otherwise considered residents under the Hungarian Personal Income Tax Act but whose income is derived from Hungary. Such cases include income earned by a US individual from short-term employment or interest earned in Hungary.

A further adverse consequence of the termination of the treaty is that income from stock exchange transactions derived from US sources may no longer qualify as controlled capital market transactions. In addition to the 15% personal income tax, such income would also be subject to the 13% social contribution tax. Plus, profits and losses on individual transactions may no longer be offset against each other.

Is a revised treaty on the cards?

As a consequence of the termination of the convention, the definition of permanent establishment under domestic law will be relevant as the preferential rules will no longer apply. Thus, for example, in the case of construction work, US companies will be deemed to have a taxable permanent establishment in Hungary in a much shorter time period than before – three months instead of 24 months.

While Hungarian companies and individuals could therefore be most affected by the effects of the treaty’s termination, it has long been clear that the US is not satisfied with the content of the old treaty, which does not contain, for example, the Limitation on Benefits (LOB) clauses.

There have been efforts to renew the treaty since the mid-2000s, including the drafting of a new tax treaty in 2010. However, while the new draft would have replaced the 1979 version, it has not yet entered into force because the US Senate has not ratified it. The question is whether the termination of the old treaty would give the parties sufficient incentive to conclude a new treaty by 2024.