Double taxation is a legal and financial term used to describe cases where the same income is subject to the jurisdiction of two or more countries, which can create a conflict from a tax point of view. In this article, we will look in detail at the concept of double taxation, its causes, the methods used by countries to avoid it and the means by which individuals and companies can minimise their double tax burden. Hungary has concluded double tax treaties with a number of countries, including the United States of America, but the treaty has been denounced by the United States on 8 July 2022, so the current treaty will no longer apply from 1 January 2024. We will soon discuss in a new article how anyone who earns income from the US should proceed after 1 January 2024.
What is double taxation?
Double taxation is a situation where income is subject to the tax jurisdiction of two or more different jurisdictions, for example two countries, and both jurisdictions impose tax on the same income. This situation often occurs when a person or company carries out activities in two or more countries, or when a person is a national or resident of more than two countries. The issue of double taxation should be a priority for for digital nomads.
Reasons for double taxation
In general, tax is paid according to the rules of the country of tax residence, in line with international guidelines. However, there are some countries where territorial taxation still applies. This means that personal income tax or corporate tax is only due on income from that country. However, individuals who are tax resident in the United States of America are taxed on their worldwide income, regardless of territoriality.
Territorial taxation and lack of clear rules:
Most countries apply the so-called territorial taxation principle, whereby only income earned within the country is taxable. However, the application of this principle is not always clear-cut and can easily lead to double taxation if the two countries have not concluded a double taxation convention.
Lack of tax conventions
Tax treaties between countries, in particular the Double Taxation Convention, can help prevent double taxation. These conventions define how tax liabilities are treated when the same income is taxable in two countries. If there is no proper tax treaty between two countries, there is no effective legal environment to avoid double taxation. A double taxation convention also determines which legal or natural person is taxable under the provisions of which country.
Different tax systems and legislation in force:
Different countries have different tax systems. Tax rates, tax bases, tax breaks and rules may vary from country to country. This makes it even more difficult to avoid double taxation. For example, many countries apply tax rates that depend on the level of income, known as progressive taxation. As income increases, the percentage of tax payable increases. In some cases, two countries may have concluded a double taxation treaty, whereby tax paid in one country is included in the tax payable in the other country or exempted from taxation in the other country, but the income is still taken into account by the other tax authority, so that other income will be taxed at a higher personal income tax rate if a higher income bracket is applied.
Avoiding double taxation
Countries and individuals or companies can use a variety of methods to avoid double taxation.
Application of tax conventions:
Tax treaties between countries (double taxation conventions) help avoid double taxation. These treaties determine which country taxes income and often provide for tax relief or exemption in one country to avoid double taxation.
Application of tax credits:
A tax credit means that an individual or company can offset the tax paid in one country against the tax due in another. This can help minimise the burden of double taxation.
Unilateral tax recognition:
Some countries use tax recognition, which allows the taxpayer to pay tax only in the country where the income is earned, thus avoiding double taxation.
Some states provide tax exemptions for certain types of income or persons to avoid double taxation.
Double taxation for companies
Double taxation of legal entities can be particularly complicated as companies can operate in several countries and earn different types of income. Businesses must comply with the requirements of the tax authorities of each country concerned and find the best way to avoid double taxation.
Some companies use tax havens or countries with low tax rates to minimise their tax burden, as these countries have lower tax rates. However, such practices are increasingly attracting the attention of the international community and many countries have enacted legislation against such tax avoidance activities, regulating for example: the physical infrastructure of legal entities, the habitual residence of the company's headquarters or even of the senior managers who actually take decisions for the company and the tax laws in force in relation to them.
Double taxation for individuals
Avoiding double taxation can also be a challenge for individuals. Working or earning income in two or more countries can complicate tax liabilities. Individuals need to ensure that they do not incur tax liabilities in two countries on the same income and find ways to reduce the tax burden.
Tax experts and financial advisers can help individuals and legal entities avoid double taxation and minimise their tax burden. In Hungary, tax lawyers, accountants and tax advisers can also help.
Double taxation in Hungary
The first thing to check is whether there is a double taxation convention between the Hungarian State and the country in question. If there is a convention between the two countries on taxation and it has entered into force, its contents will be familiar and regulate most of the cases and types of income that occur. Double taxation can arise in several ways.
Hungarian person earns income abroad
If there is a tax treaty between the two countries, that settles the relationship. If you actually work abroad and therefore live abroad, you should register this with your local authority. The government office will also notify the tax office and the social security authorities. This can help in any disputes that may arise later.
A Hungarian natural or legal person may receive investment income, whether it be capital gains, dividends or interest income. In the absence of an effective treaty, they may, for example, claim withholding tax on dividends in the paying country and claim payment of taxes in Hungary. For example, if you receive income from an investment in the United States, after 1 January 2024 your brokerage firm will deduct 30% withholding tax. In this case, I believe this raises ethical questions, because if you live in Hungary and use Hungarian infrastructure, why should you pay the price to the United States of America.
Foreign person earns income in Hungary
The tax law in Hungary is in line with the OECD recommendations, so the obligation to pay taxes is classically based on the place of tax residence. In the case of natural persons, the most important parameters are the address, habitual residence and centre of vital interests. For example, in the case of a legal or natural person's use of immovable property in Hungary, the tax liability arises in all cases in Hungary. In all other cases, the place of habitual residence and the place of establishment, place of business and place of supply for corporate tax purposes will be decisive. In the European Union, the free movement of labour and goods and the common set of rules make these simple to sort out.
Double taxation is a complex issue that poses many challenges and problems for international taxation and tax policy. Tax treaties between countries, tax credits, tax recognition and tax exemptions are used to minimise the burden of double taxation. Where multiple tax liabilities arise, they should seek expert advice to avoid double taxation and always take into account the requirements of tax authorities and their tax obligations in a complex international tax environment. If you need more details, please contact us or use the form below.