The new tax treaty between France and Luxembourg is now signed. Here are its main features.
The new treaty draws on the 2017 OECD multilateral instrument (“MLI”) and the 2017 OECD model, in particular regarding the permanent establishment definition.
You will find hereinafter a summary of the main modifications of the treaty together with our comments based upon a preliminary analysis:
1. Preamble: The preamble of the tax treaty is amended to include the sentence proposed by Article 6 of the MLI regarding treaty abuse. It therefore aims at limiting double taxation without creating opportunities for non-taxation or reduced taxation through tax evasion or avoidance.
2. Persons covered: Luxembourg tax transparent entities (partnerships) are excluded, in principle from the definition of resident for treaty purposes. Exceptions to this principle are very limited. French partnerships are treated as tax residents of France.
3. Resident: The new treaty adopts the standard OECD definition of tax residence. Accordingly, only persons who are liable to tax are held residents for tax treaty purposes. The new treaty also amends the previous tie-breaker rule regarding corporate residence: as a result, companies should have their tax residence in the State of their effective place of management.
4. Anti-abuse: Under a specific anti-abuse clause, the recipient of an income who is not the beneficial owner is excluded from treaty benefits. In this respect, trust or fiduciary arrangements are especially pointed at.
Moreover, a general anti-abuse rule based on the “Principal Purpose Test” is included in the new treaty. In short, it provides that a benefit under the treaty shall not be granted if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining this benefit was one of the principal purposes of a transaction or an arrangement.
5. Permanent establishment: The permanent establishment definition inserted in the new treaty is fully based on the BEPS definition (it also corresponds to the French position vis-à-vis the MLI, unlike the positions of the Luxembourg in that respect).
In particular, the definition of a dependent agent is extended in order to include a person acting in a State on behalf of a foreign enterprise and who, in doing so, habitually concludes contracts or habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the foreign enterprise, when these contracts are in the name of the foreign enterprise, or for the transfer of the ownership of, or the granting of the right to use, property owned by that foreign enterprise or that foreign enterprise has the right to use, or for the provision of services of that enterprise.
Other BEPS-inspired modifications deal with the scope of the preparatory and auxiliary activities exemption and the introduction of an anti-fragmentation rule taking into account activities conducted by closely related enterprises.
6. Business profits: The new provision on business profits retains the latest version of Article 7 of the OECD Model. Another provision also explicitly grants France the right to implement domestic CFC rules.
7. Branch tax: France is entitled to apply its domestic branch tax without rate limitation.
8. Dividends: The definition of dividends is amended in order to include deemed dividend distributions. In addition, distributions derived from real estate investment vehicles (such as OPCIs) are taxed as follows:
- If the beneficial owner holds less than 10% in a French REIT, a 15% withholding tax is levied;
- If the beneficial owner holds at least 10% in a French REIT, a withholding tax is levied at the domestic rate, meaning 30% if the recipient is a Luxembourg corporation subject to tax or, 15% in case the recipient is a Luxembourg REIT equivalent to a French REIT.
9. Interest: the new treaty provision on interest grants an exclusive taxing right to the residence State of the beneficiary, which contrasts with the old treaty which allowed the source State to levy a withholding tax up to 10%. The treaty also protects the right for France to implement domestic rules restricting interest deductibility.
10. Royalties: the new treaty introduces a right for the source State to levy a 5% withholding tax, subject to the condition that the recipient is the beneficial owner of the royalty.
11. Capital gains: The treaty is amended to include the taxation of gains realised upon the disposal by individuals of substantial participations (i.e. exceeding 25% of the rights in the company’s benefits) in the State of the company whose shares are transferred. This taxing right is however granted to the source State only to the extent that the seller has been a resident of that State within a five year period before the disposal. This is designed to neutralise the tax effects of a recent change of residence before the shares are disposed of.
The draft treaty does not change the main features of the tax regime applicable to real estate gains. It however makes clear that the rule which allows the source State to tax capital gains on shares (where the value of these shares is derived for more than 50% from immovable property) applies if the 50% threshold has been crossed during the 365 days preceding the alienation.
12. Income from employment: The article addressing income from employment has been amended in order to be in line with the current OECD model. Moreover, under the new treaty, a French resident employed by a Luxembourg company but working, even partially, in France is now subject to tax in France on the portion of his activity pertaining to the working time in France, except if this period does not exceed 29 days per year.
In addition, the elimination of double taxation clause has been amended and now provides that, in case of a French resident deriving Luxembourg-source wages subject to tax in Luxembourg, the corresponding Luxembourg tax entitles to a tax credit against French tax.
13. Directors’ fees: Directors’ fees are taxed in the State of residence of the director and in the State of the company paying the fees (taxation in the company State entitles to a tax credit against the residency State tax).
14. Elimination of double taxation: this provision is much more detailed than it used to be. One may note, in particular, that the new treaty provides that dividends subject to withholding tax in France are taxed in Luxembourg, which will in return grant a tax credit.
15. Other provisions: A specific clause of the new treaty entitles France to apply other domestic anti-avoidance rules (rent-a-star company rules and CFC-type rules regarding individuals)
16. What’s next?
It remains to be seen when the treaty will become applicable. In the meantime, its impact on current structures involving France and Luxembourg should be scrutinised closely, with a view to adapting them to this new tax environment. We will be happy to discuss with you the solutions tailored to your needs and constraints.