Overview of Hungary & US Double Tax Treaty

US & Hungary Income Tax Treaty

Overview of Hungary & US Double Tax Treaty: The United States and Hungary have entered into a Tax Treaty. Aside from the income tax treaty, the United States and Hungary have entered into other international tax agreements as well such as a Foreign Account Tax Compliance Act Agreement (FATCA); Totalization Agreement, and an Estate and Gift Tax Treaty. It is important for Taxpayers who qualify as residents of either country — and generate income — to be aware of how either country may tax that individual based on the source of the income and residence of the Taxpayer. Our Board-Certified Tax Law Specialist team has summarized the basics of the Hungary/US Tax Treaty. Let’s go through the basics of the US and Hungarian tax treaty:

US & Hungary Income Tax Basics

In general, the default position is that a Taxpayer who is a US person such as a US Citizen, Legal Permanent Resident, or Foreign National who meets Substantial Presence Test is taxed on their worldwide income. This would also include income that is being generated in Hungary, and may be tax-free or exempt under the tax rules of Hungary — unless an exception, exclusion or limitation applies (such as with pension).

Saving Clause in Hungary/US Income Tax Treaty

As we work through the United States/Hungary Tax Treaty, one important thing to keep in mind is the saving clause. The saving clause is inserted into tax treaties in order to limit the application of the treaty to certain residents/citizens. With the saving clause, each country retains the right to tax certain citizens and residents as they would otherwise tax under general tax principles in their respective countries — absent the tax treaty taking effect.

• • • Except to the extent provided in paragraph 5, this Convention shall not affect the taxation by a Contracting State of its residents (as determined under Article 4 (Resident)) and its citizens. Further, except to the extent provided in paragraph 5 and notwithstanding the other provisions of this Convention, a former citizen or former long-term resident of a Contracting State may, for the period of ten years following the loss of such status, be taxed in accordance with the laws of that Contracting State.

What Does This Mean?

The Saving Clause is inserted into a tax treaty in order to allow each country to reserve the right to tax citizens and residents the way that they would otherwise tax them had the treaty not been in effect. Despite the insertion of the saving clause into a tax treaty, there are exceptions to the saving clause as well —

Exception to the Saving Clause

• • • The provisions of paragraph 4 shall not affect: a) the benefits conferred by a Contracting State under paragraph 2 of Article 9 (Associated Enterprises), paragraphs 1 b), 2, and 3 of Article 17 (Pensions and Income from Social Security) and Articles 23 (Relief From Double Taxation), 24 (Non-Discrimination), and 25 (Mutual Agreement Procedure); and b) the benefits conferred by a Contracting State under Articles 18 (Government Service), 19 (Students and Trainees), 20 (Professors and Teachers), and 27 (Members of Diplomatic Missions and Consular Posts), upon individuals who are neither citizens of, nor have been admitted for permanent residence in, that State.

What Does This Mean?

It means that despite the saving clause — which is used to limit the application of the treaty as a certain types of income circumstances in scenarios — there are some exceptions to the saving clause which then provides that even though the saving clause reserves the right to limit the application of treaty benefit — the exceptions to the Saving Clause are not limited by the Saving Clause.

Permanent Establishment

• • • For the purposes of this Convention, the term “permanent establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on.

      The term “permanent establishment” includes especially: a) a place of management; b) a branch; c) an office; d) a factory; e) a workshop; and f) a mine, an oil or gas well, a quarry, or any other place of extraction of natural resources.

      3. A building site or construction or installation project, or an installation or drilling rig or ship used for the exploration of natural resources, constitutes a permanent establishment only if it lasts, or the exploration activity continues for more than twelve months.

      4. Notwithstanding the preceding provisions of this Article, the term “permanent establishment” shall be deemed not to include: a) the use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise; b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery; c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise; d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or of collecting information, for the enterprise; e) the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character; 7 f) the maintenance of a fixed place of business solely for any combination of the activities mentioned in subparagraphs a) through e), provided that the overall activity of the fixed place of business resulting from this combination is of a preparatory or auxiliary character.

What Does This Mean?

If a resident of one country has a Permanent Establishment (PE) in the other country, then that other country has the right to tax income generated from the Permanent Establishment within its borders. But, if there is no permanent establishment in place, then the mere fact that a non-permanent establishment generates income in the other country does not allow that other country to tax the income.

Income From Real Property

• • • Income derived by a resident of a Contracting State from immovable property (real property), including income from agriculture or forestry, situated in the other Contracting State may be taxed in that other State.

      The term “immovable property (real property)” shall have the meaning which it has under the law of the Contracting State in which the property in question is situated. The term shall in any case include property accessory to immovable property (real property), including livestock and equipment used in agriculture and forestry, rights to which the provisions of general law respecting landed property apply, usufruct of immovable property (real property) and rights to variable or fixed payments as consideration for the working of, or the right to work, mineral deposits, sources and other natural resources. Ships, boats and aircraft shall not be regarded as immovable property (real property).

      The provisions of paragraph 1 shall apply to income derived from the direct use, letting, or use in any other form of immovable property (real property).

What Does This Mean?

This article provides that if income is earned by residents of one country, as a result of real property that is located in the other country — then it may be taxed in that other country. And, since it does not use the word shall, it presumes that either country may be able to tax the income. Still, foreign tax credits from a US perspective should avoid a US person from having to pay tax to both the United States and Hungary on the same income (although the foreign tax credit is not always a dollar-for-dollar credit).

Dividends

• • • Dividends paid by a company that is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other State.

    • However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident and according to the laws of that State, but if the dividends are beneficially owned by a resident of the other Contracting State, except as otherwise provided, the tax so charged shall not exceed: a) 5 percent of the gross amount of the dividends if the beneficial owner is a company that owns directly at least 10 percent of the voting stock of the company paying the dividends; b) 15 percent of the gross amount of the dividends in all other cases. 11 This paragraph shall not affect the taxation of the company in respect of the profits out of which the dividends are paid. 

    • Notwithstanding paragraph 2, dividends shall not be taxed in the Contracting State of which the company paying the dividends is a resident if: a) the beneficial owner of the dividends is a pension fund that is a resident of the other Contracting State; and b) such dividends are not derived from the carrying on of a trade or business by the pension fund or through an associated enterprise.

What Does This Mean?

When dividends are paid by a company of one country to a resident of that other country, then that other country has the opportunity to tax the income. Noting, that the first country (aka country of source) still gets the opportunity to tax the income — but may only tax the dividend income up to a certain tax rate not to exceed 15%.

Interest

• • • Interest arising in a Contracting State and beneficially owned by a resident of the other Contracting State may be taxed only in that other State.

    • Notwithstanding the provisions of paragraph 1: a) interest arising in Hungary that is determined with reference to receipts, sales, income, profits or other cash flow of the debtor or a related person, to any change in the value of any property of the debtor or a related person or to any dividend, partnership distribution or similar payment made 13 by the debtor or a related person may be taxed in Hungary, and according to the laws of Hungary, but if the beneficial owner is a resident of the United States, the interest may be taxed at a rate not exceeding 15 percent of the gross amount of the interest; b) interest arising in the United States that is contingent interest of a type that does not qualify as portfolio interest under United States law may be taxed in the United States but, if the beneficial owner of the interest is a resident of Hungary, the interest may be taxed at a rate not exceeding 15 percent of the gross amount of the interest; and c) interest that is an excess inclusion with respect to a residual interest in a real estate mortgage investment conduit may be taxed by each State in accordance with its domestic law.

What Does This Mean?

Interest is a bit different than dividends from a taxation perspective — but oftentimes, the net-result is the same. The interest tax rules follow a residence-based concept, which means that if the interest is earned by resident of one country then it will only be taxed in that one country — of course, there are exceptions, exclusions and limitations to be aware of as well. 

Capital Gains

• • • Gains derived by a resident of a Contracting State that are attributable to the alienation of immovable property (real property) situated in the other Contracting State may be taxed in that other State. 

    • For the purposes of the application of this Article by the United States, the term “immovable property (real property) situated in the other Contracting State” shall include: a) immovable property (real property) referred to in Article 6 (Income from Immovable Property (Real Property)); and b) a United States real property interest. 

    • For the purposes of the application of this Article by Hungary, the term “immovable property (real property) situated in the other Contracting State” shall include immovable property (real property) referred to in Article 6.

What Does This Mean?

The capital gains rules provide that when gains are earned by a resident of one country as a result of alienating immovable property located in the other country — then the other country has the opportunity to tax the income. It is important to evaluate the definition of the term alienation of movable property to determine whether that particular type of asset qualifies.

Pensions

• • • • • Pensions and other similar remuneration beneficially owned by a resident of a Contracting State shall be taxable only in that State. b) Notwithstanding subparagraph a), the amount of any such pension or remuneration arising in a Contracting State that, when received, would be exempt from taxation in that State if the beneficial owner were a resident thereof shall be exempt from taxation in the Contracting State of which the beneficial owner is a resident.

        • Notwithstanding the provisions of paragraph 1: a) payments made by the United States under provisions of the social security or similar legislation of the United States to a resident of Hungary shall be taxable only in the United States; and b) payments made by Hungary under the mandatory pension scheme of Hungary to a resident or citizen of the United States shall be taxable only in Hungary.

        • Where an individual who is a resident of one of the States is a member or beneficiary of, or participant in, a pension fund that is a resident of the other State, income earned by the pension fund may be taxed as income of that individual only when, and, subject to the provisions of paragraph 1, to the extent that, it is paid to, or for the benefit of, that individual from the pension fund (and not transferred to another pension fund in that other State).

What Does This Mean?

Pensions are always an integral part of any tax treaty. Paragraph 15 provides that pension earned by resident of one country is only taxable in that country. But, when referring to Social Security payments and other public pensions, it is taxed by source, which means the country that is making the payment gets the opportunity to tax the income. A portion of the pension application (Paragraph 2) is exempted from the Saving Clause.

Government Service

• • • Notwithstanding the provisions of Articles 14 (Income from Employment), 15 (Directors’ Fees), 16 (Entertainers and Sportsmen), 19 (Students and Trainees) and 20 (Professors and Teachers): a) Salaries, wages and other remuneration, other than a pension, paid by a Contracting State or a political subdivision or a local authority thereof to an individual in respect of services rendered to that State, or subdivision or local authority shall, subject to the provisions of subparagraph b), be taxable only in that State; b) such remuneration, however, shall be taxable only in the other Contracting State if the services are rendered in that State and the individual is a resident of that State who: 18 i) is a national of that State; or ii) did not become a resident of that State solely for the purpose of rendering the services. 

    • Notwithstanding the provisions of paragraph 1 of Article 17 (Pensions and Income from Social Security):

What Does This Mean?

When it comes to government service, it is important to note that if a person earns renumeration — including pensions as a result of working for the government — then those public funds are only taxable in that country — subject to residence at the time of earning the property.

Relief from Double Taxation

• • • In the case of Hungary, double taxation will be relieved as follows: a) Where a resident of Hungary derives income that, in accordance with the provisions of this Convention may be taxed in the United States, Hungary shall, subject to the provisions of subparagraphs b) and c), exempt such income from tax. b) Where a resident of Hungary derives items of income that, in accordance with the provisions of Articles 10 (Dividends) and 11 (Interest), may be taxed in the United States, Hungary shall allow as a deduction from the tax on the income of that resident an amount equal to the tax paid in the United States. Such deduction shall not, however, exceed that part of the tax, as computed before the deduction is given that is attributable to such items of income derived from the United States. c) Where in accordance with any provision of the Convention income derived by a resident of Hungary is exempt from tax in Hungary, Hungary may nevertheless, in calculating the amount of tax on the remaining income of such resident, take into account the exempted income. d) The provisions of subparagraph a) shall not apply to income derived by a resident of Hungary where the United States applies the provisions of this Convention to exempt such income from tax or applies the provisions of paragraph 2 of Article 10 or paragraph 2 of Article 11 to such income.

    • In accordance with the provisions and subject to the limitations of the law of the United States (as it may be amended from time to time without changing the general principle hereof), the United States shall allow to a resident or citizen of the United States as a credit against the United States tax on income applicable to residents and citizens: a) the income tax paid or accrued to Hungary by or on behalf of such resident or citizen; and b) in the case of a United States company owning at least 10 percent of the voting stock of a company that is a resident of Hungary and from which the United States company receives dividends, the income tax paid or accrued to Hungary by or on behalf of the payer with respect to the profits out of which the dividends are paid. For the purposes of this paragraph, the taxes referred to in paragraphs 3 a) and 4 of Article 2 (Taxes Covered) shall be considered income taxes.

What Does This Mean?

This is more of a general provision that provides that the purpose of the tax treaty is to avoid certain double taxation — and that subject to certain restrictions in the different articles, double taxation will prevent a person from being taxed twice on the same income.

Exchange of Information

• • • The competent authorities of the Contracting States shall exchange such information as is foreseeably relevant for carrying out the provisions of this Convention or of the domestic laws of the Contracting States concerning taxes of every kind imposed by a Contracting State to the extent that the taxation thereunder is not contrary to the Convention, including information relating to the assessment or collection of, the enforcement or prosecution in respect of, or the determination of appeals in relation to, such taxes. The exchange of information is not restricted by paragraph 1 of Article 1 (General Scope) or Article 2 (Taxes Covered).

    • Any information received under this Article by a Contracting State shall be treated as secret in the same manner as information obtained under the domestic laws of that State and shall be disclosed only to persons or authorities (including courts and administrative bodies) concerned with the assessment, collection, or administration of, the enforcement or prosecution in respect of, or the determination of appeals in relation to, the taxes referred to above, or the oversight of such functions. Such persons or authorities shall use the information only for such purposes. They may disclose the information in public court proceedings or in judicial decisions.

What Does This Mean?

The exchange of information provision is designed to further enforce the fact that the purpose of the tax treaty is to promote cooperation and to facilitate any exchange of information necessary for each country to obtain the goals and objectives of being in a double taxation agreement with the other country.

Offshore Reporting (FBAR & FATCA) & United States/Hungary Tax Treaty

When a US person has various Accounts, Assets or Investments in Hungary, they have to reported to the United States each year on various different forms depending on the value of and category of the assets/accounts.

Here are some common forms which may need to be filed:

5 International Tax Forms You May Have Missed

The following is a summary of five (5) common international tax forms.

FBAR (FinCEN 114)

The FBAR is used to report “Foreign Financial Accounts.” This includes investments funds, and certain foreign life insurance policies.

The threshold requirements are relatively simple. On any day of the year, if you aggregated (totaled) the maximum balances of all of your foreign accounts, does the total amount exceed $10,000 (USD)?

If it does, then you most likely have to file the form. The most important thing to remember is you do not need to have more than $10,000 in each account; rather, it is an annual aggregate total of the maximum balances of all the accounts.

Form 8938

This form is used to report “Specified Foreign Financial Assets.”

There are four main thresholds for individuals is as follows:.

• Single or Filing Separate (in the U.S.): $50,000/$75,000
• Married with a Joint Returns (In the U.S): $100,000/$150,000
• Single or Filing Separate (Outside the U.S.): $200,000/$300,000
• Married with a Joint Returns (Outside the U.S.): $400,000/$600,000

Form 3520

Form 3520 is filed when a person receives a Gift, Inheritance or Trust Distribution from a foreign person, business or trust. There are three (3) main different thresholds:

• Gift from a Foreign Person: More than $100,000.
• Gift from a Foreign Business: More than $16,076.
• Foreign Trust: Various threshold requirements involving foreign Trusts

Form 5471

Form 5471 is filed in any year that you have ownership interest in a foreign corporation, and meet one of the threshold requirements for filling (Categories 1-5). These are general thresholds:

• Category 1: U.S. shareholders of specified foreign corporations (SFCs) subject to the provisions of section 965.
• Category 2: Officer or Director of a foreign corporation, with a U.S. Shareholder of at least 10% ownership.
• Category 3: A person acquires stock (or additional stock) that bumps them up to 10% Shareholder.
• Category 4: Control of a foreign corporation for at least 30 days during the accounting period.
• Category 5: 10% ownership of a Controlled Foreign Corporation (CFC).

Form 8621

Form 8621 requires a complex analysis, beyond the scope of this article. It is required by any person with a PFIC (Passive Foreign Investment Company).

The analysis gets infinitely more complicated if a person has excess distributions. The failure to file the return may result in the statute of limitations remaining open indefinitely.

*There are some exceptions, exclusions, and limitations to filing.

Receiving a Gift or Inheritance From Hungary

If you are a U.S. Person and receive a gift from a Foreign Person, Foreign Business or Foreign Trust, you may have to file a Form 3520. The failure to file these forms may lead to IRS Fines and Penalties (see below).

Which Banks in Hungary Report U.S. Account Holders?

As of now, there are nearly 2000 Foreign Financial Institutions, within Hungary that report US account holder information to the IRS. The FFI list can be found here:

What is important to note, is that the list is not limited to just bank accounts. Rather, when it comes to FATCA or FBAR reporting, it may involve a much broader spectrum of assets and accounts, including:

• Bank Accounts
• Investment Accounts
• Retirement Accounts
• Direct Stock Ownership
• ETF and Mutual Fund Accounts
• Pension Accounts
• Life Insurance or Life Assurance Policies

Totalization Agreement & the United States/Hungary Tax Treaty

The purpose of a Totalization Agreement is to help individuals avoid double taxation on Social Security (aka U.S. individuals living abroad and who might be subject to both US and foreign Social Security tax [especially self-employed individuals] from having to pay Social Security taxes to both countries).

As provided by the IRS:

• • • “The United States has entered into agreements, called Totalization Agreements, with several nations for the purpose of avoiding double taxation of income with respect to social security taxes.

      These agreements must be taken into account when determining whether any alien is subject to the U.S. Social Security/Medicare tax, or whether any U.S. citizen or resident alien is subject to the social security taxes of a foreign country”

The United States has entered into 26 Totalization Agreements, including Hungary.

United States/Hungary Tax Treaty is Complex

In conclusion, The US and Hungary tax treaty is a great source of information to help better understand how certain income may be taxed by either country depending on the source of income, the type of income and the residence of the taxpayer. The tax outcome may be changed depending on whether or not the savings clause impacts how tax rules will be applied for certain types of income.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, and specifically IRS offshore disclosure.

Contact our firm for assistance.