Globalised world – wide range of opportunities – complex rules
With the international mobility of individuals becoming a natural phenomenon, the emergence of international postings to meet the business needs of multinational groups, as well as the appearance of international remuneration schemes (typically based on company shares) sponsored by these groups, it has become common by the 21st century that an individual would earn income from more than one source. The unstoppable development of information technology and the financial awareness that has grown partly as a result have been further catalysts. In many cases, the source of income is outside the physical borders of Hungary, and a law-abiding individual may even have difficulty in identifying the country that is the source of his or her income. Not to mention that keeping records of foreign income, accurately determining the amount of such income, as well as calculating and declaring the resulting tax liabilities can be a complex challenge for individuals.
Why is it important to pay attention to the taxation of foreign income?
It is essential to raise awareness that each individual is responsible for carrying out the tax tasks required by his or her income situation, even if the acquisition of foreign income is not the result of a conscious decision (for example, if the employer introduces a group share scheme in Hungary and automatically includes all employees). A lack of due attention may lead to a number of negative effects, including the following:
- the income may bear a higher tax burden than justified, resulting in less net income for the individual;
- failure to pay the tax is also a real risk, as it – if revealed by the tax authority - could result in the obligation to pay a supplementary surcharge or even fines;
- failure to declare income and file a tax return may also be the basis for a fine;
- furthermore, failure to maintain adequate and systematic records may cause us to be lost in the information, with the result that we can fall into the trap of the above omissions.
What are some of the key points to be familiar with?
In the following we will list and briefly explain the essential points that you should be aware of when carrying out your taxation related tasks in connection with foreign income.
1. Bilateral treaties
Hungary currently has bilateral tax treaties in force with 90 countries. It is important to determine whether there are any bilateral treaties the provisions of which should be taken into account when determining income and the related tax liability. Hungarian law also has provisions for the case where no such treaty exists, but it is essential to prepare ourselves that the taxation of foreign income in two countries will probably have to be dealt with in substance and the aggregate tax rate on income will probably be higher than it would be if a treaty had been in place. Bilateral tax treaties usually regulate important aspects of the taxation of incomes from various activities as well as private capital nature incomes, and they provide guidance on how the countries concerned avoid the double taxation of income.
2. Tax residence and source country
Tax residence is the most important factor affecting personal taxation. The determination of tax residence (both under the domestic law of any country and under the criteria of any double taxation treaty) places the individual on the world map of tax and all other tax considerations must be treated with a view to this origo. An individual is deemed to be resident for tax purposes in the country with which he or she has the closest links. However, it is up to each country to decide which of the individual’s characteristics, attributes or circumstances it considers relevant for tax purposes and as the basis of domestic tax residence. If more than one country considers the individual to be resident for tax purposes under its domestic law, the treaty between them should be used to determine in which country the individual is ultimately considered to be resident for tax purposes. In the absence of such a treaty, both countries may consider the individual to be resident under their domestic law, and this is where the tax difficulties really begin.
The determination of the country of tax residence of the individual and the separation of the income according to countries of source is important because, although as a general rule all income of the individual is taxable in his or her country of tax residence, the source country often has the possibility to withhold a certain amount of tax on that income. Any double taxation situation that may arise is also resolved by the treaty by specifying how double taxation can be avoided (crediting or exempting).
3. Determination of the place where income is earned (source country)
In addition to the determination of tax residence, it is therefore also very important to understand where the foreign income originates from, in which country it is deemed to have been earned, i.e. what is the source country. The determination of the source country may not only have an impact on the country in which the income in question is taxable, but may also affect the way in which it is to be declared. For many types of income, the source country is clearly defined based on the tax treaty, whereas for other types of income the source country of foreign income can only be determined through the interpretation of domestic legal rules. The importance of determining the source country can be illustrated by the following two examples:
Example 1: Trading stocks online
The possibility to trade with the stocks of many of the world’s major companies is now available to everyone. In practice, this most often means active trading on an online platform or placing orders with a broker over the phone. However, many people have the misconception that in case an individual trades through a bank or investment service provider registered in Hungary, then the purchase and sale of the stocks itself is also deemed to be a domestic transaction and since any dividends on the shares are also received by the individual through the investment service provider, many believe that the dividend also constitute domestic income.
Unfortunately, the situation is much more complicated than this and the truth is just the opposite. In the case of trading securities, the source country is the country where the company issuing the stocks bought or sold is registered. In other words, if someone sells the stock of a German car company with the help of a Hungarian investment service provider at a higher price than originally purchased and/or receives dividends from that company, the source country of such income will be Germany. For this reason, it is necessary to examine what rate of withholding tax, under the German-Hungarian bilateral tax treaty, Germany is allowed to apply, for example, for dividends (and to check also how much it has actually withheld).
Example 2: Crypto investments
Due to the nature of crypto assets, such transactions are only possible through an online crypto exchange, and it is also typical that the developers of the assets offered for trading through these platforms are not registered companies in Hungary. It would be therefore natural to assume that the profits made on the trading of crypto assets would constitute foreign income. However, this assumption is also incorrect. Since bilateral tax treaties do not contain any specific restrictions or source country definitions for crypto assets, a Hungarian tax resident individual should take into account the provisions of the Hungarian Personal Income Tax Act when determining the source country. This law contains rules on where income is deemed to be earned for a number of types of income, but does not cover all income in detail. If there is no specific rule for a type of income, it is deemed to be earned in Hungary. And this is also true for income from transactions in crypto assets.
4. The conversion of income denominated in a foreign currency or earned in foreign currency into HUF
It is a very important rule that in Hungary both the income and the tax must be assessed, declared and paid in Hungarian forints. The dividend on an Amazon stock, however, is denominated in USD, a BNP Paribas ETF stock in EUR, and a Mitsubishi stock in JPN. For this reason, in connection with paying taxes on foreign income, it is very essential to pay attention to which day’s exchange rate is to be used for converting the income earned in a currency other than HUF. It is also important to note that in many cases the law allows you to choose between several exchange rates, in which case it is worth choosing the one that is more favourable from a tax point of view.
5. Difference between income from activities and capital gain
A fundamental distinction to make is between incomes from activities and of capital nature. This is not only due to the considerations mentioned above, but also because when taxing foreign incomes it is important to take into account not only the personal income tax consequences that arise, but also the possible social security aspects. If a person is insured in the Hungarian social security system, under certain conditions, he or she may be liable to pay and declare social contribution tax also with respect to his or her capital nature incomes. On the other hand, such an obligation is definitely applicable in case of participation in an employee share scheme, as the exercise of a share option, for example, is considered as income derived from employment and as such it is subject to social contribution tax. And this is valid even if the income acquired is a share.
6. Tax return and payment obligations and deadlines
Different tax payment deadlines may apply to different types of income. While the tax on capital nature private income must be paid by 20 May of the year following the year in question, the tax advances on income forming the part of the consolidated tax base must be paid quarterly.
Therefore, once it is established if the foreign income:
- is considered as income subject to consolidation or is separate taxable income;
- is subject to advance tax liability and, if so, by what deadline;
- is subject to a social security (social contribution tax) liability;
- then the country of source, the amount of income in HUF, the amount of withholding tax deducted and deductible should be determined, and
- finally, the most important thing, the declaration of the income and the payment of the tax can take place.
Summary
The above tasks can be quite multi-layered and complicated, and therefore we recommend that you consult a tax adviser if you have any questions about the taxation of foreign income. Mazars is happy to offer its assistance and expertise on the subject.