Determining tax residency is of key importance in deciding where to pay taxes after income. Normally, a country may levy a tax on income if the individual generating it has tax residency in the given country. However, if an individual is resident of more than one country, the question of where to pay taxes arises.
To avoid double taxation of the income generated by an individual, many countries entered double taxation treaties. These set up objective rules, based on which anyone can decide in which jurisdiction they should pay taxes.
The local tax authority will always be able to inform you about the status of your tax residency, and give you a certificate of tax residency if you are a tax resident.
Double taxation treaties in Hungary
Hungary has double taxation treaties with many countries. They are all based on the OECD Model Tax Convention on Income and Capital, but they may differ slightly in each case. What they have in common is that they all clearly define the persons and taxes covered, how tax residency should be determined, what a permanent establishment of a business is, and which jurisdiction has the right to tax each type of income.
How to determine tax residency?
To determine tax residency, first you have to see which countries are involved (where the person is resident, where the business operates), and then check if there is a double taxation treaty in place between these countries. Then you can proceed as described in the treaty.
Of course, there are some general rules that are the same in most treaties. An individual is resident of a “contracting state” (as the OECD refers to jurisdictions involved) if they are liable to paying taxes in that jurisdiction under the local laws based on their domicile, residence, place of management or any other similar criterion mentioned in the specific double tax agreement. Usually the following rules apply.
- An individual can be deemed a tax resident only in the contracting state where they have a permanent home.
- If a permanent home is available to the individual in both countries, they shall be deemed resident of the state with which their personal and economic relations are closer (and it is the center of their vital interests).
- If the center of vital interest cannot be determined (or no permanent home is available to them in either of the states), they shall be deemed resident only of the state where they have a habitual abode.
- If the individual has a habitual abode either in both States or in neither of them, they shall be deemed resident only of the state of which they are a national.
- If the individual is a national of either both states or neither of them, the competent authorities of the two contracting states shall settle the question by a mutual agreement.
Based on the above guidelines, it can be decided with certainty where an individual’s income is taxable if they have more than one country of residence: in Country A or in Country B. Moreover, in case there are any doubts regarding an individual’s tax residency in a given country, a tax certificate can be requested from the local tax authority (this is advisable in any case).
Scenarios when tax residency is determined
Below you can see some typical scenarios where determining tax residency is involved in paying taxes appropriately.
- Country A: where the individual has tax residency for any of the reasons listed above.
- Country B: where the income of the individual is coming from.
If Country A and B are the same country, it is obvious that this country has the right to tax the income. If Country A and B are different, the double tax treaties will determine where taxes should be paid, usually based on the type of income. Possible scenarios:
Scenario 1: The income is taxable only in Country A, and according to the rules of Country A
Scenario 2: The income is taxable only in Country B, and according to the rules of Country B
Scenario 3: The income is taxable in Country A, but Country B has the right to levy a so called “source tax” on the income according to the rules of Country B. If Country B does levy such a tax, the income may become tax-exempt in Country A (referred to as the “exemption method”), or the foreign tax may be deductible in Country A (referred to as the “credit method”).
Paying taxes on different kinds of income
Where multiple residency is involved, the taxation of each kind of income will be determined by the specific double taxation agreement governing the two countries involved. However, below are listed some rules that can be considered general and apply in many treaties.
Income from real estate: the income shall be taxed only by the country where the real estate is located, i.e. where the income is derived from (usually Scenario 2 above).
Dividend: When a company registered in Country B pays dividend to an individual who is resident of Country A, dividend is usually taxed in Country A. However, the source country (Country B) may have the chance to levy a source tax, depending on the double taxation treaty between the countries (resulting in Scenario 1 or Scenario 3). In case of a Hungarian company and its owner, this source tax may be 0-15%.
Interests: When a company registered in Country B pays interests to an individual who is resident of Country A, interests are usually taxed in Country A. However, the source country (Country B) may have the chance to levy a source tax, depending on the double taxation treaty between the countries (resulting in Scenario 1 or Scenario 3). In case of a Hungarian company and a foreign shareholder, this source tax may not exceed 10%.
Salary (income from employment): When a company registered in Country B pays salary to an individual who is resident of Country A, the salary (or other remuneration) is usually taxed in Country B if the work is performed in country B (resulting in Scenario 2), and country A if the work is performed in country A. (resulting in Scenario 1)
For example, if an IT company in Country B employs people living in Country A through teleworking, the employees will have to pay taxes in Country A.
Posting, delegation, or secondment
When employees are posted to another country (that is, they remain employees of the company in their home country (the “delegating country”) and they carry out work at a company in a “host Country”, they may be taxed in their home country if all conditions listed below are met:
- if the employee spends less than 183 days in a period of 12 month in the host country and
- the salary is paid by an Employer who is not a tax resident in the host country and
- the salary cost is NOT born by the Employer’s office or another permanent establishment in the host country
If not all conditions are met, the employee has to pay taxes in the host country
However, even if all the above conditions are met, there is still a chance that taxes have to be paid in the host country. The latest commentary on the OECD Model Convention introduced the term “economic employer”. This means that if an individual has an employment contract with a company in their country of residence but is posted to a position in another (host) country – and is working in the interest of a that host country company –, a so-called “integration test” shall be performed in order to determine the “economic employer” of the individual and decide which country can tax the salary regardless where the work is performed. As a result, even if the individual spends less than 183 days at the company in the host country, the host country will have the right to tax the salary if the economic employer is determined to be the company in the host country.
As a result, the economic employer might be different from the legal employer. The integration test consists of certain questions described in the Commentary mentioned above. The Hungarian tax authority observes the rules of applying an “economic employer” in determining where income should be taxed.
Need help? Call an expert!
If you have any doubts regarding your tax residency, it is always a good idea to consult an expert. Asking the right questions can save you a lot of hassle in the long run. Our tax advisors will be happy to answer your questions and help you plan your activities. Contact us today!
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Disclaimer: The data in this article reflect the state of affairs upon publication. To get up-to-date information, always consult your accountant.