Hungary: new US double tax treaty

A new double tax treaty with the US is in the process of being ratified, and contains changes which might prompt businesses to review their current structures.

Once ratified, the withholding tax elements of the treaty are expected to come into force during 2010. The remainder will not come into force until 1 January 2011.

The treaty will include ‘grandfathering’ provisions allowing tax payers to choose to take advantage of any benefits under the old treaty until 31 December 2010.

The treaty mainly follows the 2006 US Model Income Tax Treaty, with minimal influence from Hungarian tax treaty policy.

One new feature is a comprehensive "limitation on benefits" clause, included due to US anti-treaty shopping rules. It is similar to those found in recent tax treaties between the US and other European countries and requires residents seeking access to treaty benefits to satisfy: 

• the qualified entity test, by being an individual, government organization, publicly-traded corporation (or subsidiary of one) or a tax-exempt organisation (such as a pension fund)
• the ownership/base erosion test
• the active trade or business test
• the "fewer than seven owners" test
• the company headquarters test

Other key changes from the old treaty include: 

• treating building sites as permanent establishments if they last for more than 12 months (previously 24 months)
• a (soft) commitment to adjust taxes as appropriate using transfer pricing principles (the "Associated Enterprises" article)
• the possibility of an exemption from withholding tax for dividends beneficially owned by pension funds, in line with the latest US tax treaty policy
• special rules apply to dividends paid by certain US investment vehicles, such as REITs and RICs
• anti-abuse exceptions (eg for US source contingent interest payments and Hungarian sourced interest paid by reference to profits) to the general withholding tax exemption for interest payments
• a new reference to beneficial ownership in the exemption for royalties from withholding tax
• increased scope to tax capital gains, allowing US tax to be payable on capital gains arising from US property interests held through REITs or RICs, and Hungarian tax to be payable on capital gains arising from the sale of participation in a Hungarian real estate company
• allowing individuals who change their country of residence and are subject to an "exit tax" on latent capital gains in one of the countries to elect to treat the value of property held at the time of changing residence as having been acquired at its fair market value at that time
• tightening the rules on tax exemption for teachers and professors, but allowing students a USD 9,000 tax exemption for income from personal services carried out in the host state during their studies.