On 20 March 2018, France and Luxembourg entered into a new tax treaty (the “New Treaty”) which significantly amends provisions of the former tax treaty favorable to Luxembourg persons investing in France.
We explain hereafter our first comments on the main provisions of the New Treaty.
France and Luxembourg entered into a first double tax treaty in 1958 which was then amended on 4 occasions: in 1970, 2006, 2009 and 2014 (the “Old Treaty”).
Both countries have decided to modernize the Old Treaty and to bring it into compliance with the new OECD Model tax Convention released in November 2017.
The New Treaty will be applicable as from the first calendar year following the one during which the New Treaty is ratified. The length of the ratification process is variable and requires several steps (parliament’s agreement, ratification by the President/the Grand Duke and ultimately exchange of diplomatic notes). The earliest possible application date of the New Treaty would be 1 January 2019.
Pursuant to the New Treaty, a tax resident is a person who, under the laws of a contracting State is liable to taxes in such contracting State by reason of his domicile, his residence, his/its place of management or business.
As opposed to the Old Treaty (under which no “subject to tax” condition was provided), entities which are fully exempt from income tax, such as OPCIs or SICAV-FPS’, are not regarded as residents for purpose of the New Treaty and thus do not benefit from its provisions. As an exception, certain collective investment vehicles can benefit from the provisions of the New Treaty relating to dividends or interest.
The definition of “dividends” provided by the New Treaty is far broader than the definition set forth by the Old Treaty. “Dividends” are now defined as any income which is subject to dividend taxation under the laws of the State of establishment of the distributing company. Consequently, deemed dividends and liquidation proceeds are now treated as dividends under the New Treaty.
Dividends distributed by French resident entities to Luxembourg residents are now subject to the following treatment:
The New Treaty also provides for a specific treatment applicable to dividends paid by certain real estate investment vehicles which (i) annually distribute most of their profits and (ii) benefit from a corporate tax exemption on their real estate income. Under these provisions, dividends paid out of income or gains deriving from real estate and distributed by these investment vehicles:
Under this clause, dividends distributed by SIIC companies and paid out of their SIIC exempt profits would be subject to French withholding tax at 15% or 30%[1] depending on the Luxembourg shareholder’s participation (10% or more). The same treatment would apply to dividends distributed by French OPCIs and other French investment vehicles such as SICAV-FPS and SCR.
The withholding tax may be reduced down to 15% (even for Luxembourg shareholders holding more than 10% in the French investment vehicle) if the Luxembourg shareholder qualifies as a collective investment vehicle meeting certain criteria.
In addition, the wording of the New Treaty could lead to consider that the 15% or 30% withholding tax only applies to dividends paid out of real estate income and gains directly made by real estate investment vehicles as opposed to those made by their subsidiaries. However, the French tax authorities may not share this favorable interpretation.
Under the New Treaty, Luxembourg is also entitled to tax dividends distributed by French real estate investment vehicles and thus may apply thereon its standard corporate income tax levied at 26%.
Under the New Treaty, capital gains made by a resident of a contracting State upon disposals of shares in entities are subject to tax in the other contracting State if, at any time during the 365 days preceding the disposal, the value of these shares is mainly derived from real estate owned, whether directly or indirectly, in this other contracting State.
The wording of the New Treaty is comparable to that of the Old Treaty but specifies the length of time during which assets of the entities concerned must be appraised. It is now clear that an entity which has sold all of its real estate assets at the time of the sale of its shares may be qualified as a real estate rich entity if it has reached the 50% real estate threshold at any time during the 365 days preceding the disposal.
Capital gains made upon the sale of shares in a company which has sold all of its French real estate would remain taxable in France during 365 days. This capital gain may be eligible to the French participation exemption regime (4.13% taxation), keeping in mind that capital gains made upon the sale of shares in OPCIs are never eligible to this regime.
French “Impôt sur la fortune immobilière” (“IFI”) is in the scope of the New Treaty and persons who are tax residents in Luxembourg benefit from provisions of the New Treaty for the determination of their IFI liability with respect to their French real estate assets.
The clause relating to wealth tax enables to consider that real estate indirectly owned by Luxembourg residents is not subject to IFI.
The New Treaty provides for an anti-abuse provision under which a benefit under the New Treaty shall not be granted if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting of that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the New Treaty.
This provision is very broad and gives large room to the French Tax Authorities to challenge schemes according to which a taxpayer benefits from the New Treaty. It is in line with article 7 of the OECD Multilateral Instrument.
[1] The 30% rate should decrease down to 28% in 2020, 26.5% in 2021 and 25% in 2022.