Technical Explanation to the 1980 Exchange of Notes (1980)

TECHNICAL EXPLANATION TO THE 1980 EXCHANGE OF NOTES (1980)

As indicated in the respective Articles, it was agreed that a number of points would be covered in an exchange of notes to accompany the treaty rather than in the body of the treaty Articles themselves. The primary reason for moving these points to an exchange of notes was to simplify the text of the treaty by removing from it a number of points which were considered elaborations of points already made or implicit in the articles. In one case with reference to assistance in collection, the provision was moved to the exchange of notes because it is regarded by Hungary as an exception to its ordinary treaty policy; no similar provision is included in the OECD Model and the issue had not previously been encountered by the Hungarian People’s Republic. The exchange of notes constitutes a part of the treaty and is legally binding on the parties.

Paragraph 1 simply states that the Hungarian People’s Republic will not impose a tax on dividends paid by a U.S. corporation out of profits of a joint venture in Hungary. The remittance tax provided under Hungarian law will be imposed, at the reduced rates provided in paragraph 2 of Article 9 (Dividends), on distributions to U.S. partners in joint ventures; no second tax will be imposed on such distributions.

Paragraph 2 provides the same rule with respect to the income covered under Article 19 (All Other Income) that is provided separately in Articles 9 (Dividends), 10 (Interest), and 11 (Royalties), to the effect that when such income is effectively connected with a permanent establishment or fixed base of the recipient of the income in the other Contracting State, it will be taxed in accordance with the provisions of Article 7 (Business Profits) or Article 13 (Independent Personal Services).

Paragraph 3 states that each Contracting State may apportion or allocate income, deductions, credits, and allowances between related enterprises of the two Contracting States in accordance with its internal law. The United States will apply its rules and procedures under section 482 of the Internal Revenue Code. The wording of this provision, which refers to “enterprises” and “dealings” and considers only related enterprises of the two Contracting States is not intended to limit the scope of application of section 482. It was agreed that both Contracting States would deal with non-arm’s length transactions in accordance with the provisions of its internal law. However, the Hungarian delegation objected to spelling out the scope of such laws in the treaty, finding the language of both the U.S. Model and the OECD Model on this point excessively complex. It was therefore decided to simply refer to internal law in the exchange of notes and allow each State to apply its law as it would do in the absence of a treaty. Similarly, the treatment of excessive interest or royalties paid between related persons will be resolved in accordance with internal law.

Paragraph 4 contains the rules usually found in paragraphs 4 and 5 of the Article on exchange of information and administrative assistance (Article 26 in the U.S. Model of May 1977). The Hungarian People’s Republic agrees to attempt to collect on behalf of the United States the additional tax due to the United States when a resident of a third country receives dividends, interest, or royalties in Hungary from which U.S. tax has been withheld at the reduced treaty rate or waived under the treaty when the recipient, not being a resident of Hungary, is not entitled to the benefits of the treaty. The provision is worded reciprocally, but is probably less relevant for Hungary which imposes its dividend tax on the distributing entity and does not withhold tax on interest paid abroad, so that the only relevant case would be with respect to the Hungarian tax on royalty payments. It is agreed that neither Contracting State in fulfilling this commitment is required to carry out administrative measures different from those used to collect its own taxes or contrary to its sovereignty, security or public policy.