The U.S Treasury announced on 15 July 2022 that on 8 July it initiated the process to terminate the currently in-force tax treaty with Hungary. Although not expressly pointing to Hungary’s opposition to the adoption of the planned global minimum tax, Treasury did refer to inequities following from Hungary’s adoption of its current low (9%) corporate tax rate.
Treasury’s action has direct implications for multinationals benefitting from the U.S.-Hungary tax treaty, as well as broader ramifications for ongoing international efforts to bring the agreed global minimum tax into force. The implications will, in part, depend on whether the delayed termination takes effect, as announced, or whether the U.S. agrees to preserve in some form Hungary’s treaty status with the U.S. in exchange for Hungary relenting in its opposition to the global minimum tax.
The U.S.-Hungary tax treaty currently in force dates from 1979. Although the two nations negotiated a revised tax treaty in 2010, the updated treaty has stalled in the U.S. Senate due to the efforts of Senator Rand Paul (R-Ky.), who for years has blocked progress to advance new tax treaties. The not-yet-approved 2010 updated treaty adds, among other changes, a limitation of benefits article, which is lacking in the existing treaty.
The termination article under the current treaty stipulates that the terminating party must provide the other country at least six months’ diplomatic notice of termination. According to the Treasury announcement, termination will be effective on 8 January 2023, although as specified in the treaty, with respect to taxes withheld at source, the Convention will cease to have effect on 1 January 2024 and with respect to other taxes, with respect to taxable periods beginning on or after that date.
The Biden Administration moved quickly in its first year to push for an international agreement setting a global minimum tax, which was ultimately agreed to at a 15% rate under Pillar Two of the OECD deal reached in October 2021 (for prior coverage, see the article in the November 2021 issue of Corporate Tax News).
Hungary, long critical of the global minimum tax proposal, ultimately agreed to join the deal in the final negotiations leading up to the October 2021 pact. However, as the EU has sought to implement the minimum tax rules via a new directive, Hungary has declared that changed circumstances prevent it from continuing to support the minimum tax (for prior coverage, see the Tax Alert dated 20 June 2022). Its opposition could block adoption by the EU, which would generally require unanimous support for such a measure (although there are talks of potential workarounds to Hungary’s opposition).
While the U.S. already has in place a form of global minimum tax through the global intangible low-taxed income (GILTI) provisions adopted in the 2017 tax reform, the current GILTI provisions are not likely to be considered a qualifying “income inclusion rule” under the OECD’s model rules. The Biden Administration has sought to enact changes to align the GILTI regime more closely with the OECD rules but has so far faced difficulty garnering the necessary votes in the Senate.
While the U.S. has yet to adopt a global minimum tax that cleanly aligns with Pillar Two of the OECD pact, the adoption of such a tax by the EU would likely put increased pressure on U.S. lawmakers to enact such provisions. Thus, the Biden Administration may see advancing the directive in Europe as advancing its case at home. This is because if the EU acted on the tax and the U.S. did not, U.S. multinationals might be subject to the tax regardless, but with the revenues potentially flowing to Europe rather than the U.S. However, this is not necessarily the result for U.S. multinationals in the absence of GILTI amending legislation in the U.S. Although the existing GILTI regime might fail to meet the definition of a qualified income inclusion rule under the OECD model rules, it could potentially still qualify as a “controlled foreign company tax regime” under those rules (see also the Australian article in this issue of Corporate Tax News).
In addition to Treasury’s move to terminate the tax treaty creating pressure on Hungary to agree to the global minimum tax sought by the Biden Administration, it could also create pressure domestically in the U.S. for Republicans to push Senator Rand Paul to end his opposition to approving the 2010 update to the treaty with Hungary.
Hungary’s low corporate income tax rate, at 9%, is well below the current U.S. 21% rate. This fact, combined with the lack of a limitation-of-benefits article in the treaty that is currently in force, leaves the convention open to treaty shopping. The Obama Administration had sought to address such concerns through its 2010 renegotiation of the treaty. However, that renegotiation also pre-dated the adoption of Hungary’s current 9% corporate tax rate and could be seen as insufficient by the present Administration.
Multinationals benefiting from the terms of the current U.S.-Hungary treaty should evaluate the effects on their business of the loss of that treaty and/or its potential replacement with the 2010 version.