For the various types of income, the treaties determine precisely which country is entitled to tax the income – the source country or the country of residence. Among the most frequent types of income we reviewed capital gains and income from the use of immovable property in the aforementioned article; now, we are focusing on one of the most significant items, income from employment.

In which year and where should the income from employment be taxed?

Special rules apply to income derived from employment activities. Income from employment and similar benefits is essentially taxable in the country of residence. The situation is different if the employee works in a country other than the country of residence, because he then has to pay taxes as a general rule in the country of employment.

If the salary of the foreign employee arriving at the company is not paid by the Hungarian company, it is not charged to the Hungarian permanent establishment of the foreign company, and the employee does not spend more than 183 days in Hungary, he pays tax in his country of residence. For the 183-day rule it is important to have accurate information about the wording of the treaty. Some of the treaties link the period to be reviewed to the fiscal or financial year, while others tie it to the calendar year. For newer treaties, any period starting or ending in the given year must be taken into account.

So for example, if an employee came to Hungary in October 2016 and stays until May 2017, whether he will have a tax liability on his salary in Hungary depends on which treaty has to be taken into account. In the case of the German-Hungarian treaty, the salary for the Hungarian activity will be taxed in Hungary in both 2016 and 2017 because there is a 12-month period starting in 2016 and ending in 2017 in which a German tax-resident employee spent more than 183 days in Hungary. So although it seems that the employee only spent a short period in Hungary in 2016, and therefore no Hungarian tax arises, he still has to file a Hungarian tax return and pay Hungarian taxes based on the special provision of the treaty. However, if the person is resident in France, he will have no tax payment liability on his salary in Hungary in either 2016 or 2017, since based on the French-Hungarian treaty, the fiscal year has to be reviewed, and his stay in Hungary did not exceed 183 days in either of the affected years.

When reviewing the 183-day rule it is important that not only working days have to be taken into account but all the days of present, including weekends and paid holidays. However, the days when the employee qualifies as a Hungarian resident do not have to be considered.

On the working days when our French-resident employee works abroad, in France or even in Spain, the income from employment will be taxable in France.

Who qualifies as the economic employer?

In addition to the above, the “economic employer” has to be scrutinised too. This is because, in an economic sense, it can happen that it is not the company that qualifies as the employer of the private individual with whom the labour contract was concluded. To determine who the economic employer is an “integration test” has to be performed to identify the extent to which the seconded employee was integrated into the host company’s organisation. During this test various criteria have to be examined, including, who is authorised to define the employee’s work procedures or approve paid holidays, who can give instructions regarding the employment, who bears the responsibility and risks connected to the employee’s work, etc.

If it is found based on the integration test that the host company qualifies as the economic employer of the employee, the employee will have to pay taxes on his salary in the country of employment even if he receives his salary from the country he came from and does not spend more than 183 days in the recipient country.

RELATED ARTICLES:

Guidelines for HR professionals – taxation of foreigners’ income in Hungary

Labour law framework for intercompany postings

Taxation of foreigners’ income in Hungary – definition of tax residency

Taxation of foreigners’ income by types of income in Hungary

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For the various types of income, the treaties determine precisely which country is entitled to tax the income – the source country or the country of residence. This does not always mean tax is actually paid, because clearly the given income could be exempt from tax in the country in question.

Let us take a look at the most common types of income.

Capital gains 

The first problem often comes when determining the type of income received. Foreign tax certificates frequently do not indicate what type of income we earned. It is often not clear whether the gain on our foreign security is a dividend or interest. Yet we cannot just decide not to define the types of income because this influences the taxes and levies payable. While a dividend generally incurs Hungarian personal income tax of 15% along with a health care contribution (eho) of 14%, the eho payable on interest was just 6% in Hungary until 2016, and from 2017 there is no eho payment liability for interest at all. There is no health care contribution payment liability for securities listed on stock exchanges either.

It is important to know that if a foreign employee does not pay contributions in Hungary because these are paid in another EU Member State (and this is proven), then no eho has to be paid on capital gains either.

In accordance with the double taxation treaties, tax essentially has to be paid in the country of residence on income from interest and exchange gains. This also means that if tax was deducted from interest in the source country, the tax deducted can be reclaimed there. We can avoid the deduction of tax in the first place by submitting a certificate of residence to the foreign bank, verifying Hungarian residency.

There are special provisions for dividend income. While income from dividends is also taxed in the country of residence, the source country has the right to tax this income as well to a certain extent. Depending on the treaty this generally means 10 or 15%. Taxes paid abroad must be taken into account in Hungary. This essentially means for example that if we earn dividend income in Germany, then Germany has the right to deduct tax of 15% under the German-Hungarian double taxation treaty. If this tax is indeed paid and 15% is deducted from our dividend, we can deduct this in turn from our tax payable in our Hungarian tax return. As the Hungarian rate of personal income tax is 15%, this means no further tax has to be paid on the German dividend.

Income from use of immovable property

In the case of income derived from immovable property, the treaties award the taxation right to the country where the property is located. This means that if a foreign employee lets out his home property while working in Hungary, the rental must be taxed in the country where the property is situated, irrespective of whether or not the individual qualifies as a Hungarian resident during his stay in the country.

The same applies to income derived from the sale of property.

Our next article looks at the third main group, income from employment.

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What aspects must be considered?

According to the majority of double taxation treaties, when a private individual qualifies as a resident in several countries at the same time based on their address, the issue of tax residency can be decided based on the following aspects:

• permanent address
• centre of vital interests
• habitual abode
• citizenship

If, after considering the above factors, it still cannot be decided where the employee qualifies as a tax resident, the countries in question have to agree on the issue.

The above list of criteria is a list of priorities too, i.e. if the tax residency can clearly be determined for the private individual based on their permanent address, no further criteria have to be examined.

Permanent address

Based on both Hungarian legal requirements and OECD guidelines, the residence where the private individual settles down for the long term qualifies as a permanent address. This can be an own or rented house or apartment, or even a permanently used room.

The criterion for a permanent address is that it should be available for the private individual continuously, for use at any time.

Let’s take an example. A Spanish person comes to work in Hungary. He has a house in Spain that he keeps and does not rent out, and he rents an apartment in Budapest. In this case, the person will have a permanent address in both countries since there is an apartment in both countries that is available at any time for use in the long run. However, if he rents out the house in Spain and de-registers there, his permanent address in Spain will cease and he will only have residence in Hungary.

Centre of vital interests 

If the private individual has a permanent address in several countries at the same time, specifying the centre of vital interests is the next step in determining residency. The centre of vital interests is in the state in which the private individual has the closest personal, family and economic relationships.

Determining the centre of vital interests entails a complex review. If the Spanish employee above brings his wife and three children to Hungary, it is likely that his closest family relations will tie him to Hungary. However, if his family remains at home and the employee visits them every weekend, then his family relations will continue to tie him to Spain.

 

When identifying economic relations, the place where income is received and spent also has to be taken into account. If the Spanish individual is employed only in Hungary, and receives income from Spain too but only in the form of dividends, this will tip the scale towards Hungary. Based on OECD guidelines, the circumstance to be reviewed in this case is where the private individual manages his assets from.

During an actual audit, the tax authority even took into account the foreign individual’s bankcard use when determining his residency. In the period under review, the private individual used his bankcard mainly in Hungary, and only rarely abroad. In addition, the private individual had full-time employment in Hungary, while he only had investments abroad, which according to the tax authority did not require any personal presence, as opposed to his employment. The income from the investments was transferred to the private individual’s Hungarian bank account. The NAV considered these facts and established Hungarian tax residency for him. A Curia judgment was also issued in that case.

In addition to the above, the private individual’s political, cultural and other activities have to be taken into account as well.

Habitual abode

Sometimes the above aspects are not enough to determine whether an employee is a Hungarian or a foreign resident; then, habitual abode has to be examined. On this basis the person will be tax resident in the country where they have spent more days.

After defining residency it can be decided where the individual incomes of the private individual are taxable.

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