Hungarian tax liabilities of companies and individuals with U.S. business interests may change significantly from 2024
US tax resident entities Hungarian tax liability extends solely to the income derived from business activity carried out through permanent establishment situated in Hungary. Following the termination of the treaty, however, an activity in Hungary may create permanent establishment (and hence result in tax liability in Hungary) more often.
The definition of permanent establishment within the scope of the Hungarian corporate tax law is broader than the definition included in the treaty, while the provisions of the treaty as an international agreement and thus a higher source of law, supersede the Hungarian domestic rules. In the absence of a treaty, it may occur that as of 2024, an entity incorporated in the US (without any change to its organisation or business activity in Hungary) will have a permanent establishment in Hungary. Therefore, such entities will incur corporate income tax liability in Hungary.
Such cases include permanent establishments created in connection with construction or mining activities. While during the term of the treaty (i.e. until the end of 2023) solely construction or mining activities carried out for longer than 24 months created a permanent establishment in Hungary, as of 2024 any such activity performed for longer than 3 months will create one.
Supply of services through a natural person employed by an US company under contract of employment or carrying out the same activity under another form of legal relationship will create a Hungarian permanent establishment (“Services PE”) for the US entity if the service is provided for a duration of longer than 183 days over any 12-month period. It is important to note that the definition of the Service PE is narrower than that of the ‘agency permanent establishment’ since the activities of the individual will create a Service PE in Hungary even if the individual is not authorised to enter into agreements on behalf of the US entity.
Withholding tax on dividends
As regards dividend income, the treaty sets forth a limit on tax liability arising in the country of source. Accordingly, the tax liability arising in the US in connection with dividends paid by a US company to a Hungarian one may not be higher than 5%, or 15% (depending on the proportion of ownership held by the beneficial owner entitled to the dividend in the entity paying the dividend).
As of January 2024, this cap will be removed and US domestic regulations will be applicable to withholding tax, when applying the prevailing 30% withholding tax rate will be likely to result in a higher tax charge.
The termination of the treaty will have even more serious consequences for interest income and royalty payments than the removal of the withholding tax cap applicable to dividends. The interest and royalty paid by a US company to a Hungarian tax resident entity have not incurred any tax liability in the US, however, those affected by this change will in the future be subject to a 30% withholding tax liability under US domestic rules.
Real property and income derived from real property
According to the treaty, income from real property may be taxed in the country where the real estate is located. In the past Hungary has applied the exemption method for the avoidance of double taxation. Thus, Hungarian tax resident companies’ income (e.g. rental income) from real estate located in the US has been exempt from Hungarian tax liability. Following the termination of the treaty, however, such income will be included in the Hungarian corporate income tax base as part of the worldwide income.
The termination of the treaty will also affect those Hungarian companies that hold real property located in Hungary and whose direct owner is a US entity. In the absence of a treaty, the gain realised on the sale of a Hungarian seated company (or the capital reduction in a company) holding real property located in Hungary will be subject to 9% corporate income tax. Additionally, these companies may also be subject to tax in the US. Please note that the Hungarian company has unlimited, joint and several liability for the Hungarian corporate income tax assessed by the tax authority yet unpaid by the US owner if the Hungarian company fails to declare to the tax authority that it qualifies as an entity holding real property.
Although the current treaty between the US and Hungary will remain applicable for approximately one more year, those with US interests should prepare for the changes taking place in January 2024. Our colleagues would be pleased to assist companies and individuals affected by these changes. We are able to provide support in reviewing incomes and contracts and determining any future additional tax liabilities. Should you have any questions regarding the above, please feel free to contact us.