Tax treaty termination: Serious consequences for U.S., Hungarian businesses

Tax treaty termination: Serious consequences for U.S., Hungarian businesses

Our tax experts, Balázs Kántor and Petra Rózsahegyi answered BBJ in connection with the serious consequences of the termination of the U.S.- Hungary double taxation agreement.

On July 8, the Hungarian government received formal notice from the U.S. government of termination of the current tax treaty between the two countries. The treaty is intended primarily to regulate various tax-related issues and in particular to avoid double taxation for taxpayers with interest in both countries.

There is the possibility that the United States wants to put pressure on Hungary for blocking the introduction of the global minimum tax instead of cutting the economic relations between the two countries. This can be inferred from the fact that the formal notice was issued after June 30 and consequently the termination will be effective from 2024. Until 2024, there is a chance that the two countries will be able to sort out the situation even by replacing the current tax treaty. The current tax treaty was already outdated and the two parties agreed on the introduction of a new treaty in the early 2000’s, however, due to political reasons, the United States failed to ratify the new treaty.

The United States is one of Hungary’s most important trade partners and consequently, the termination of the tax treaty can and will have negative consequences for many aspects of U.S.-Hungary relations. To mention a few of the most obvious and significant consequences, the following aspects of the life of companies could be affected:

The rate of withholding tax levied by the United States on dividends and interest paid by U.S. payers to Hungarian recipients will increase significantly to an amount which cannot be deducted from the Hungarian recipient’s tax base. As a result, investment in the United States by Hungarian companies or investments through a Hungarian company may no longer be feasible or profitable. Since Hungary does not currently levy withholding tax on outbound dividend or interest payments, there will be no immediate change for such flows, but this can change in the future if Hungary decides to follow the U.S. pattern and would levy withholding tax on outbound dividends or interest.

In transactions in the financing sector (in the case of financing arrangements, credit facilities, and similar), the parties usually include gross-up clauses in their agreements, i.e. the debtor is obliged to pay more to the creditor if withholding tax shall be deducted from the payment in the country of the debtor. Such clauses, however, usually only protect the creditor if the borrower is in a treaty country. By the termination of the tax treaty, both Hungarian and U.S. creditors may find that they are no longer protected from withholding tax in the other country.

The income of U.S. expatriates employed by a Hungarian company could be subject to increased (double) taxation i.e. they will not be able to rely upon the treaty to avoid double taxation. To compensate for the increased tax burden employers may need to increase the salary or otherwise change the package of the employee, increasing payroll costs.

Special arrangements between companies in the United States and Hungary may also suffer since the tax treaty (together with the judicial and professional analysis of the tax treaties) also provided a conceptual framework for the interpretation of structures and transactions. The loss of this framework will make it significantly harder to assess the tax consequences and thus the costs of such arrangements.

In addition to the direct tax consequences, this change can have serious consequences on the general U.S.-Hungary business relationship. The loss of the treaty means the loss of the foreseeability of an important cost aspect on an investment. Such increased risk will show in the business plans and projections and can reduce the attractions of cross border investment and transactions between the two countries.

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