US Treasury terminates double tax treaty with Hungary

On 8 July, US Treasury transmitted a formal notice of treaty termination to Hungary as the first step in terminating the 1979 treaty with effect from 8 January 2023 or from 1 January 2024 for taxes withheld at source.

One reason is the absence of a limitation on benefits clause in its treaty with the Hungary; as Hungary is the only country in the EU without an LOB, it is frequently used to set up financing structures that avoid U.S. withholding taxes. A renegotiated treaty with an LOB was submitted to the Senate for ratification in 2010 where it was blocked, with several other treaties, by Sen. Rand Paul. It now needs to be renegotiated to reflect law changes made by the 2017 Tax Cuts and Jobs Act.

In 1979 both countries had comparable corporate tax rates, and Hungary levied withholding taxes on cross-border dividends, interest, and royalty payments. Since then, Hungary has slashed its corporate tax rate from 50 percent to 9 percent and did away with withholding taxes on cross-border payments to non-residents.

After an analysis by US Treasury showed that the treaty conferred benefits only to Hungary, and after unproductive negotiations, Treasury decided to terminate the treaty.

Hungary has characterized this decision as retaliation for blocking the EU pillar 2 directive. Treasury has also linked its decision to terminate the treaty to its desire to get the global minimum tax deal signed, noting that Hungary’s refusal to implement a global minimum tax could exacerbate its status as a “treaty-shopping jurisdiction, further disadvantaging the United States.”

The EU has been trying to reach unanimity on a directive to implement global minimum corporate tax rules, known as pillar 2 of the two-pillar global corporate tax reform plan on which 137 jurisdictions agreed in 2021 through the OECD framework. Pillar 2 would ensure that large multinational enterprises pay an effective minimum tax rate of 15 percent in the countries in which they operate. Pillar 1 provides for the formulaic reallocation of a portion of residual profits that large multinationals make in the jurisdictions in which they have consumers.

Termination of the treaty will have ripple effects, benefits of lower tax rates on certain income (e.g. interest and dividends), exclusion for certain employment income, as well as relief from double taxation will expire. This could give rise to double taxation without relief for individual taxpayers and higher international assignment costs for mobility programs.

It will also force restructurings and likely raising effective tax rates for those who have financed investment through Hungary.

Furthermore, when Hungarian tax authorities take aggressive positions against U.S. taxpayers for historical structures, there will be no mutual agreement procedure to ensure that the IRS can help protect them from double taxation.