On July 8, the US Treasury sent Hungary a notice
of its intention to terminate the 1979 US-Hungary income tax treaty.
The notice starts the clock on a six-month advance notice period.
Assuming that the notice is not revoked within that period, the 1979
treaty will generally cease to have effect as of 2024. With respect to
withholding taxes in particular, the 1979 treaty will cease to have
effect as of January 1, 2024, which will generally result in a
30 percent US withholding tax on US-source payments. In respect of other
taxes, the 1979 treaty will cease to have effect with respect to tax
periods beginning on or after January 1, 2024.
The 1979 treaty is notable as one of the few remaining US income tax treaties without a limitation-on-benefits (LOB) article, and one of an even smaller number of LOB-free US income tax treaties that provide for 0 percent withholding tax on interest payments. These features, in combination with Hungary’s own advantageous tax rules, historically made Hungary an attractive jurisdiction for financing structures, including (especially before 2008) in connection with Canada-to-US inbound financings.
A new US-Hungary income tax treaty was negotiated and signed in 2010. Among other significant changes, the 2010 treaty included a comprehensive LOB article, including a “triangular” provision. However, the 2010 treaty was in limbo for a long time—one of the instruments that Senator Rand Paul blocked from ratification votes, citing privacy concerns with the information exchange provisions. Although the protocols managed to get ratified in 2019 through the support of Senator Mitch McConnell, the US Treasury raised concerns that certain treaties (those with Hungary, Poland, and Chile) may override the base erosion anti-abuse tax provision enacted as part of the Tax Cuts and Jobs Act of 2017, thus further delaying the coming into force of the 2010 treaty.
The US Treasury’s move to terminate the 1979 treaty appears to be primarily prompted by Hungary’s continuing opposition to the European Union’s adoption of a 15 percent global minimum tax pursuant to the OECD pillar 2 initiative, which the Biden administration champions. The Treasury Department stated that the benefits of the treaty “are no longer reciprocal,” given the lowering of the Hungary corporate tax rate from 19 percent, in 2010, to its current 9 percent rate; a Treasury official was quoted as saying that Hungary’s refusal to implement the global minimum tax “could exacerbate Hungary’s status as a treaty-shopping jurisdiction, further disadvantaging the United States.” It has been said that such concerns apply equally to the 2010 treaty. Hungary, on the other hand, has refused to adopt the global minimum tax on the basis of concerns about its adverse impact on the European Union’s competitiveness and on jobs in Hungary.
It remains to be seen whether the US threat to terminate the 1979 treaty will cause a shift in Hungary’s position in the short term or whether possible political wins by the US Republican Party (which appears to share Hungary’s concerns about pillar 2) in this year’s mid-term elections and beyond may cause a reversal of the US termination of the 1979 treaty. In light of this uncertainty, Canadian multinationals with US inbound financing structures that involve Hungary should carefully consider the implications for such structures of the announced termination of the 1979 treaty.
Michael Kandev and Jennifer Lee
Davies Ward Phillips & Vineberg LLP, Montreal and New York