Tax-Free Pensions in Hungary – Still if Coming from a Foreign Private Pension Fund

In today’s world, pensioners are geographically mobile, so some of the luckiers can spend most of the year even in warmer climates. However, the question may arise: in which country are their income taxed? In the following, we discuss the taxation of pensions in Hungary, especially considering that those are tax-free in Hungary.

Tax residence

The scope of the Hungarian Personal Income Tax Act covers individuals, their income and the tax liability related to this income, but it lays down different rules regarding the income of certain individuals.

A resident individual is subject to full tax liability whose tax liability covers all his income.

Non-resident individuals have a limited tax liability, as their tax liability only covers income originating in Hungary based on the place where they are earned or otherwise taxable in Hungary based on an international treaty (limited tax liability).

The Personal Income Tax Act also states that the provision of an international treaty shall apply if an international treaty contains a provision different from the provisions of the Personal Income Tax Act.

International conventions used in tax matters aim to ensure that only one country is liable to tax on a given income.

Bilateral treaties excluding double taxation are generally based on the OECD Model Tax Convention on Income and Wealth. The Model Convention is issued by the OECD (Organisation for Economic Co-operation and Development), and the Commentary on it is also of paramount importance from the point of view of the application of international tax law. Hungary is a member of the organization, so the application of the Commentary is mandatory. (The provisions of the Model Convention are also the starting point in this article.)

In everyday practice, the starting point should always be the convention involved. Hungary has tax treaties with more than 90 countries aimed at avoiding double taxation, and the number of these treaties is constantly growing.

Therefore, the country in which an individual is liable to tax, for example, must be determined on the basis of the relevant double taxation convention.

Residency determines to which state an individual has the most direct connection for tax purposes. Following the Model Convention, tax treaties generally describe the criteria for determining residence in Article 4. A resident is generally a person who is taxable in the Contracting State by reason of his domicile, registered office, place of business management or any other criterion.

In some cases, further examination is necessary to determine tax residence, considering the individual’s domicile, centre of vital interests, habitual residence and nationality.

Taxation of Pensions

Most of the conventions settle the taxation of pensions, retaining the right to tax in the country of residence of the individual, but they do not define the concept of pension.

In defining the meaning of the term ‘pensions and similar pay’, explanatory notes to Article 18 of the Model Convention should be considered. Those payments include, on the one hand, pensions paid to former employees and, on the other, pensions paid to the worker’s widowed spouse, partner and children, as well as annuities paid after previous employment. The payment may even be lump sum, if it otherwise falls within the scope of the concept of pension (e.g. if the age limit has been reached, it is paid after a certain period of service, based on a contribution related to previous employment).

However, it is important to note that the individual facts and circumstances surrounding the payment should be analysed to decide whether a regular or one-off payment can be considered as pension in Hungary, and thus, treat this payment as tax-free income of the individual.

Most double taxation treaties limit the scope of application of pension rules only to pensions paid for former employment. There are also conventions which allow the application of this article to pensions and similar reimbursements, for example in respect of liberal professions. However, many states recognize individual pension schemes – bank savings accounts, individual investment funds, life insurance – as pensions, applying more favourable tax rules to them.

In the absence of restrictive provisions, these rules may apply not only to pensions paid under social security, but also to those paid under private and individual pension schemes in lump-sum.

It should also be considered that certain tax treaties limit the “taxability” of pensions in Hungary (which is actually tax-exemption), since in some cases pensions that are incurred in one Contracting State and are paid to a resident of the other Contracting State in respect of previous work can only be taxed in the first State.

However, since pensions are tax-free in Hungary, it is worth to consider to move to Hungary as retirement approaches, at least for a period when a larger amount is paid in lump-sum, e.g. in the case of a lump sum withdrawal of a private pension fund investment. (Consultation with a tax advisor is strongly recommended for the application of the above.)