In mid-March 2023, the international community was shaken by Russia's announcement of the termination of agreements related to double taxation avoidance with what it termed "unfriendly countries." Among these countries was Hungary. This decision, set to take effect from August 8, 2023, marked a significant shift in tax policies affecting transactions between Russia and Hungary. However, while Russia took a unilateral stance, Hungary chose not to reciprocate, opting to uphold its obligations under the existing tax treaty. This article delves into this intricate world of tax and legal matters, exploring the real-world implications of this development and shedding light on the complexities faced by individuals and businesses in both countries.
The Genesis of the Agreement
The bilateral tax treaty between Russia and Hungary, established in 1999, aimed to prevent double taxation and fiscal evasion of income taxes for individuals and companies operating in both countries. This treaty delineated the respective tax jurisdictions of Russia and Hungary, providing guidelines for the taxation of various types of income, like employment income, dividends, interest, capital gains and royalties.
Russia's Unilateral Action
Russia's decision to terminate the tax treaty with Hungary was a bold move with far-reaching implications. By suspending the application of certain provisions of the treaty, Russia signaled its intent to assert its sovereignty over tax matters concerning transactions with Hungary. This move prompted concerns among Hungarian taxpayers, who faced uncertainty regarding their tax obligations on income derived from Russian sources.
Hungary's Response
In response to Russia's action, Hungary issued a statement reaffirming its commitment to the existing tax treaty. Despite Russia's decision to suspend certain provisions, Hungary reiterated its adherence to the treaty's terms and vowed to continue applying its provisions to transactions with Russia. This stance provided a measure of reassurance to Hungarian taxpayers, who could continue to rely on the treaty's provisions to mitigate the risk of double taxation.
Impact on Hungarian Taxpayers
However, for Hungarian taxpayers receiving income from Russian sources, Russia's termination of the tax treaty raised several questions about their tax obligations. While Hungary continued to honor the treaty, Russia's unilateral action meant that Hungarian taxpayers could no longer benefit from certain tax exemptions and reductions provided for in the treaty. This created a scenario where Hungarian taxpayers faced the prospect of paying higher taxes on income derived from Russia.
Complexities in Tax Calculations
According to Hungarian regulations, e.g. individuals deriving income from countries without an active tax treaty with Hungary can mitigate double taxation in accordance with the Hungarian tax rules. Depending on the nature of the income, individuals may have the option to include foreign taxes paid when calculating their Hungarian tax liability.
- First, if the consolidated tax base (which includes employment income, like salary and director fee) for the tax year includes income on which the individual has paid tax abroad, unless otherwise provided for in an international agreement, the calculated tax is reduced by 90% of the tax paid abroad on the income, but not more than the tax otherwise applicable in Hungary.
- On the other hand, in the case of so-called separately taxed income (which includes investment income, like dividends, interests, capital gains), in the absence of an international treaty a resident individual has the option to reduce the calculated tax by the amount of tax paid abroad on the income. However, the tax payable may not be less than 5% of the taxable amount.
However, for individuals considered residents of Hungary under a tax treaty and those whose income is subject to taxation in Hungary, the applicable treaty's provisions supersede the Hungarian rules. This means that Hungarian tax authorities must apply the terms of the treaty, including the taxation of Russian-sourced income, even in the absence of a bilateral agreement.
Thus, if an individual is resident in Hungary and/or the income can be taxed in Hungary according to the Treaty, then – as the Convention overrides Hungarian rules – it is not possible to include the tax deducted in Russia. Therefore, the Russian sourced income of an individual, who is resident in Hungary, must be declared and the corresponding tax should be paid in Hungary in all cases where, under the Convention, the right of taxation rests with Hungary. (If, according to the agreement, income should be taxed in full in Hungary, while e.g. 20 percent tax was deducted in Russia, then the tax deducted in Russia cannot be included in the tax payable on income subject to Hungarian tax, i.e. the individual bears 20 + 15 percent, i.e. 35 percent tax.)
In contrast, if there were no agreement, 90 percent of the 20 percent, but not more than 15 percent (which is the Hungarian tax rate), could be credited when determining the Hungarian tax liability, meaning that the individual would not be subject to additional personal income tax in Hungary.
The above interpretation also follows the tax authority's statement, according to which the tax treaty "cannot completely avoid double taxation of the incomes of individuals and businesses unilaterally, so the Russian suspension may affect the cross-border incomes of both individuals and businesses. The Convention shall apply only to income taxed in the Russian Federation in accordance with the Convention, and consequently, only income which is taxed by the Russian Party in accordance with the provisions of the Convention may be exempted from tax in Hungary."
However, in case of investment income subject to taxation, the tax deducted may be included to the extent specified in the convention. As stated in the announcement of the tax authority, "the tax deducted in the Russian Federation shall be credited only in respect of dividend income and up to a maximum of 10 percent, in accordance with the withholding tax permitted by the Convention." This means that if the Russian company deducts 20 percent tax from the dividends paid to Hungarian resident individuals, then in Hungary only 10 percent of this can be set-off, i.e. the remaining 5 percent must be paid when filing the personal income tax return.
Persistent Application of Specific Articles
However, the Communication of the tax authority also states that the provisions of a general and technical nature of the Convention which are not subject to suspension and which are set out in certain articles will continue to apply, such as the possibility of 'resolving conflicts arising from dual residence' (for example, if a person were to be considered a resident under the domestic law of both countries, Article 4 of the Convention) or the initiation of dispute settlement (Article 25 of the Convention).
Implications for Businesses
Although we have analysed above the tax implications of individuals, the termination of the tax treaty had also significant implications for businesses operating in both Russia and Hungary. Companies engaged in cross-border transactions faced increased complexity and uncertainty regarding their tax liabilities. Without the clarity provided by the tax treaty, businesses had to navigate a patchwork of domestic tax laws, potentially exposing them to double taxation and compliance risks.
Social Security Considerations
In addition to tax implications, the termination of the tax treaty also raised questions about social security obligations and benefits. The social security agreement between Russia and Hungary governs the rights and obligations concerning social security.
However, it should be noted that, unlike the tax convention, the social security convention between Hungary and Russia, remains in force and still applicable. But, since the tax and social security obligations should be analysed together, with the termination of the tax treaty, individuals, and related entities, like employers, had to assess the impact on their social security entitlements and obligations and plan accordingly.
Conclusion: Navigating Uncertain Terrain
The termination of the tax treaty between Russia and Hungary marked a significant development in international tax law. While Hungary chose to uphold its obligations under the treaty, Russia's unilateral action introduced uncertainty and complexity for individuals and businesses operating in both countries. Navigating this uncertain terrain requires careful consideration of legal and tax implications, as well as proactive compliance measures to mitigate risks and ensure regulatory compliance. As the global tax landscape continues to evolve, staying informed and adapting to changes will be essential for taxpayers and businesses alike.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
