On March 20th 2018, a new double tax treaty was signed between Luxembourg and France (hereafter the “Tax Treaty”), which includes such details as amended notions of permanent establishment, tax residency referring to effective tax liability and introduces a general anti-abuse provision. As a novelty, the scope is extended to other French oversea territories and will include the “French social contributions” (CSG and CRDS). The Tax Treaty includes BEPS compliant provisions and follows the latest OECD standards. The main aspects of the Tax Treaty are the following:
- The “resident” definition under the Tax Treaty is now in line with the latest OECD model and solely includes persons who are subject to tax. Trustees and fiduciaries that are not the beneficial owner of the income cannot be treated as residents in the sense of the Tax Treaty; it is rather the beneficiary himself that could qualify. With regards to French partnerships, groups of persons and other assimilated entities, they can now also qualify as “resident”, provided that (i) their place of effective management is located in France, (ii) they are fully subject to tax and (iii) all their partners are fully taxable in France on their share of the profit of said entity.
- The permanent establishment definition also includes commissionaire arrangements, i.e. situations where a dependent agent, without material modification by the company, habitually plays the principal role in leading to the conclusion of contracts. Said arrangements could now lead to the constitution of a permanent establishment. Additionally, independent agents may now also constitute a PE, in cases where they act exclusively or almost exclusively on behalf of one or more enterprises to which they are closely related.
- A 5% dividend withholding tax is foreseen in cases where a company, who is the beneficial owner, holds at least 5% of the share capital of the distributing company for a period of at least 365 days prior to the distribution. Dividends paid by exempt distributive real estate investment vehicles, such as French “SPPICAVs” or “SIICs”, will be subject to a 15% withholding tax, but only if the shareholder owns, directly or indirectly, less than 10% of the share capital of said vehicle. If the shareholder owns more than 10%, the domestic withholding tax rate would apply.
- With regards to capital gains, not only the capital gains on real estate assets will be taxed in the country where the real estate asset is located, but also the capital gains on shares of companies who derive more than 50% of their value from real estate assets located in that country. As a novelty, said test will look back at the last 365 days prior to the disposal, to assess whether the conditions are met. Another specific measure has also been added for individuals that have been resident in the other contracting state during the previous five years. In this case, the disposal of shares representing a substantial participation (a direct or indirect participation of 25% in the profits, together with related persons) is taxable in the other contracting state.
- For cross border employees, the country of residence will regain taxation right over the employment income that has been earned in the country of employment, once the period spent outside the country of employment (i.e. in the country of residence or in a third country) exceeds 29 days. Additionally, French-resident individuals working in Luxembourg will not benefit from an exemption of French tax on their Luxembourg employment income, but rather benefit from the credit method, for the amount of Luxembourg tax suffered.
- The Tax Treaty includes anti-abuse rules under the form of a principal purpose test, which allows Luxembourg or France to deny treaty benefits. Such denial can take place, if obtaining said benefit was one of the principal purposes of the arrangement or transaction, unless it is demonstrated that granting that benefit was in accordance with the object and purpose of the relevant provisions of the Tax Treaty. France also expressly included the possibility, in the protocol to the Tax Treaty, to apply its domestic anti-abuse rules, irrespective of any contrary provisions in the Tax Treaty.
- Lastly, the protocol to the Tax Treaty provides specific rules regarding undertakings for collective investment (hereafter “UCI”). Despite the fact that they are not treated as resident under the Tax Treaty (due to the lack of taxation), they may nonetheless benefit from the provisions of the Tax Treaty with regards to dividend distributions and interest payments, to the extent that (i) the UCI can be assimilated to an UCI of the other contracting State and that (ii) the beneficiaries of the UCI are residents of one of the contracting States or of a State with which the source State (of the payment) has concluded a treaty regarding the administrative assistance to combat tax fraud and tax evasion.
The entry into force of the Tax Treaty is scheduled for January 1st of the year following the ratification of the Tax Treaty, which might be as soon as January 1st 2019, if the ratification process is completed in both countries before the end of the year.
In conclusion, real estate investments, which typically take place through French SPPICAVs or SIICs will be the most impacted by the provisions of the Tax Treaty and will likely require swift restructuring, given the fact that the new Tax Treaty might enter into force as early as 2019. Financial institutions and other actors of the Luxembourg financial sector active in France through agents’ type of structures should also review their commercial model to avoid falling within the new permanent establishment definition.