On 20 March 2018, the French and Luxembourg Governments signed a new double tax treaty (DTT), together with an accompanying Protocol.
This new DTT could be applicable from as soon as 1 January 2019 if the respective Parliaments of the two Contracting States ratify it prior to 31 December 2018 which on the French side is most likely to be the case.
Once in force and effective, the new treaty will replace the old France-Luxembourg Income Tax Treaty dated 1 April 1958.
The major changes, in line with BEPS recommendations, are the followings:
Resident (article 4): a person “subject to tax”
The new DTT defines a resident – and thus a person entitled to access treaty benefits – as a person “subject to tax” in one of the two Contracting States.
The clause of article 4 that deals with double residence situations concerning legal entities retains the “place of effective management”. The notion of residence is in consequence defined more restrictively than in the current DTT meaning that companies having solely a registered office in one of the two States or that are not subject to tax will not benefit from the new DTT provisions.
The new DTT expressly confirms that French SCIs and some other similar types of entities for which shareholders are personally liable to tax are deemed resident in France in the meaning of the DTT.
Permanent Establishment (article 5) : a new definition in line with OECD work
The definition of a permanent establishment under the new DTT is in line with recent OECD work, and notably the recommendations made by the OECD Action Plan 7 Final Report (“Preventing the Artificial Avoidance of Permanent Establishment Status”).
In particular, “commissionaire” arrangements are expected to be regarded as permanent establishments of the “principal” enterprise, as are any other arrangements where a party acting in one country on behalf of an enterprise habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification in the name of the enterprise.
In addition, a party that acts in a country exclusively or almost exclusively on behalf of one or more closely related enterprises is not deemed an independent agent and may be regarded as a permanent establishment.
The changes also restrict the application of a number of exceptions to the definition of permanent establishment to activities that are preparatory or auxiliary in nature. They ensure that it is not possible to take advantage of the aforementioned exceptions through the fragmentation of a cohesive operating business into several smaller operations.
Dividends (article 10): a full exemption from withholding tax and an extended definition of dividends
With respect to dividends, a 0% withholding tax rate is now applicable when the beneficial owner is a resident company of a Contracting State that holds directly at least 5% of the share capital of the distributing company during a period of 365 days (inclusive of the dividend payment date).
For other holdings that cannot qualify for the withholding tax exemption mentioned above, the treaty rate of withholding tax under the new DTT is 15%, unchanged from the current DTT.
Finally, the new definition of dividends provided in the DTT now includes deemed distributions meaning any distribution that domestic law assimilates to a dividend distribution. In France, this covers liquidation proceeds of French companies as well as the fraction of excess interest paid to shareholders.
Interest (article 11): full exemption from withholding tax
While under the old treaty a 10% withholding tax was applicable on interest payments, the DTT now provides for a full exemption from withholding tax i.e. cross-border interest payments are taxable only in the recipient’s country of residence. This treaty relief is however limited to the “arm’s length” portion of the interest.
Royalties (article 12): a 5% withholding tax
The new article 12 now provides for a 5% withholding tax on royalties payments in the payer jurisdiction whereas the current DTT provides for a full exemption.
Capital gains (article 13): redefinition of real estate companies
Capital gains are to be taxed exclusively in the country where the person disposing of the asset is a resident. However, as an exception to this principle, capital gains are taxed in the country where the asset is located (State B) in the following cases:
- disposal of real estate situated in State B
- disposal of movable property allocated to a permanent establishment situated in State B
- shares in a real estate entity defined as any company, trust or other entity deriving directly or indirectly at any time over the 3365 day period preceding the disposal, more than 50% of its assets value from real estate property located in State B. Immovable property used to carry out the own trading activity of the entity is not taken into account.
Furthermore, capital gains derived by an individual from the disposal of a substantial shareholding (i.e. giving right, either directly or indirectly, alone or together with connected persons to at least 25% of the profits) held in a company are taxable in the country where the company is a resident if the individual making the disposal has migrated from the country where the company is a resident within the 5 previous years.
Entitlement to Benefits (article 28)
In line with the commitments made by France and Luxembourg under the MLI, the Principal Purpose Test (PPT) provision has been included in the new DTT.
Elimination of double taxation (article 22)
Under the new DTT, the tax credit method is applicable to all types of income whereas under the current DTT, French tax residents are relieved from double taxation using the “exemption with progression” method according to which income is tax exempted but nevertheless taken into account to calculate the progressive income tax rate applicable to other income taxable in France.
Undertakings for Collective Investment: paragrah 2 of the Protocol
The Protocol to the Treaty extends the benefits of articles 10 (dividends) and 11 (interest) to undertakings for collective investment UCI that are established in one Contracting State and that are assimilated under the legislation of the other Contracting State to its own UCIs.