U.S. Treasury makes rare move to terminate tax treaty with Hungary amid minimum tax debate

July 2022

BY

Michael MasciangeloManaging Director, International Tax Services Practice Leader

Matt WilliamsPrincipal, International Tax Services

The U.S Treasury on July 8 announced that it was initiating the process to suspend the currently in-force tax treaty with Hungary, according to reports in Reuters and other sources. 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.

The 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 tax treaty status with the U.S. in exchange for Hungary relenting in its opposition to the global minimum tax.
 

Current U.S.-Hungary tax treaty

The tax treaty currently in force between the U.S. and Hungary dates from 1979. The two nations had negotiated a revised tax treaty in 2010. However, 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 treaty that is currently in force.

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. The treaty would then generally cease to have effect on the January 1 that follows the expiration of the six-month notice period.
 

Global minimum tax negotiations

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.

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 European Union has sought to implement the minimum tax rules, Hungary has declared that changed circumstances prevent it from continuing to support the minimum tax. Its opposition could block adoption by the European Union, 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.
 

Next steps and key takeaways

While the U.S. has yet itself to adopt a global minimum tax that cleanly aligns with Pillar Two of the OECD pact, the adoption of such a tax by the European Union 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 European Union 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.

In addition to Treasury’s move to terminate the 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.