Termination of U.S.-Hungary Tax Treaty Will Hurt More in Long Run

Analysis

Károly Radnai, managing partner of Andersen in Hungary

From 2024, Hungary is expected to be the only EU Member State without an effective double taxation treaty with the United States. Its absence could cause unforeseeable damage to the Hungarian economy and is a significant disadvantage in the competition for foreign investment.

On July 8, 2022, the U.S. Department of the Treasury announced the termination of the treaty with Hungary on the avoidance of double taxation concluded in 1979, although it remains in force until January 1, 2024. Washington has never previously imposed such a sanction on any country with significant economic potential.

U.S. Waiting for an Excuse

The convention was highly advantageous for Hungary. For this reason, the United States put intense pressure on our country 15 years ago to renegotiate the treaty, which resulted in a new agreement in 2010, but it was not ratified overseas for internal political reasons. It was not confirmed later because, in just a few years, this document has also become “obsolete” for the American party due to the major tax reform taking place there.

Washington was probably just waiting for the right excuse to terminate the old agreement, which was becoming increasingly disadvantageous for them unilaterally. Their communication suggests that this excuse was mainly motivated by the Hungarian position against introducing the global minimum tax. The Hungarian government seems to have adopted the wrong tactics on that issue, mistakenly believing that the global minimum tax was a good tool to fight for leeway and advantages against the European Union while, in fact, getting its opponents mixed up.

A Basic Safeguard

The Treaty on the Avoidance of Double Taxation formed the basis of Hungarian-U.S. trade relations and contributed to making Hungary an attractive location for American investors. Issues like investment protection, type of income taxes, and a mutual agreement procedure were covered by the treaty, which was in force for more than 40 years between the two countries. Thus, it was suitable for providing essential safeguards for economic operators. From 2024, the Hungarian and U.S. legal systems will not be able to replace that individually and independently of one another.

Negative Economic Impacts

The adverse effects of the treaty’s termination will not necessarily be felt in the short term, but rather in the longer term, it will undoubtedly create serious uncertainty among investors. It will mainly be reflected in the lower level of investments and a shift of service functions to other countries.

Without an agreement, the United States can change its domestic law at any time (e.g., impose a withholding tax on service fees paid to Hungary in addition to passive income), which could marginalize Hungary as an investment destination. In addition, American investors will conceive the lack of treaty protection as an additional risk factor in their decisions, considering that currently, decades-old rules on global taxation are in transition in international tax relations. Furthermore, investors may also consider Hungary a country where a withholding tax could be imposed at any time on outbound payments, which would have a negative effect on the level of return on investments.

New Agreement Needed Immediately

According to the information available, there are currently no substantive negotiations in progress for a new agreement, although it is in the interests of both parties. A treaty is needed that provides favorable and predictable conditions for retaining and expanding investment in both countries. However, in international practice, the negotiation and ratification of such a tax treaty is a several years long process; unfortunately, we are not even at the beginning of that.

This article was first published in the Budapest Business Journal print issue of March 24, 2023.

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