This article is a follow-up to the CMS tax conference held in London in October.
A new tax treaty between France and the United Kingdom was signed on 28th January 2004 in London. However, the current tax treaty of 22nd May 1968 will remain in force until the Parliaments of the two countries ratify the new treaty.
We had expected the new treaty coming in force in 2007, but now understand that the treaty is the subject of further discussions that may lead to a new version. It is too early to know exactly where the amendments will be but one suggestion is that the new partnership provisions are being reviewed. We will of course keep you updated as soon as we have more information.
The new treaty is largely consistent with the OECD model income tax treaty, but contains numerous changes and new provisions for companies as well as for individuals, as compared to the current treaty.
This article focuses on the following main changes:
- Nil rate of withholding tax in France on dividends paid by a 10% French subsidiary to its UK parent company (instead of a 5% withholding tax under the current treaty);
- French partnerships to be residents for treaty purposes;
- Tax treatment of French and UK members of partnerships, broadly applying the transparency principle;
- Similar treatment for investment schemes;
- Corresponding adjustments on transfer pricing;
- Capital gains;
- Application of French CFC and thin cap rules;
- Restriction on the remittance basis rule;
- Taxation in France of UK directors' fees received by French resident;
- Wealth tax treatment for UK nationals arriving in France.
Companies
1. Nil rate on dividends paid by a 10% French subsidiary.
While article 10(6)(a) of the current treaty still allows France to levy a 5% withholding tax on dividends paid by a French resident company which are beneficially owned by a UK resident company that "controls" the French resident company. Article 11(1)(c) and 11(7) of the new treaty will allow a full exemption from French withholding tax on dividends paid by a controlled French resident company to a UK resident parent company. Control means direct or indirect control, either alone or with one or more associated companies, of at least 10% of the voting power in the French resident company.
2. Treatment of partnerships
The new treaty is particularly good news for partnerships established in the UK that have French or UK resident individual investors and that make investments in French or UK resident companies.
i) UK residents members of a UK partnership
Under article 30 (a), UK resident investors will be deemed to realise directly any French income or gains derived by a UK partnership and will then benefit from all tax treaty provisions. For example, if there is a distribution of royalties in France to a UK resident through a UK partnership, no withholding tax will be levied in France.
ii) French residents members of a UK partnership
French resident investors will be deemed to realise directly any UK or French income or capital gains derived by a limited partnership (article 30 (b) (ii)).
Therefore, if a French company invests in the UK through a limited partnership and realises capital gains from the disposal of shares in a French or a UK company, it will be taxed at the reduced rate of 19% in France. Under the current treaty, the French company would have been subject to corporation tax on this capital gain at the rate of 33.33% (plus additional contributions).
iii) UK residents members of a French partnership
Under article 4 of the new treaty, and in accordance with French domestic law, French partnerships are considered as resident for tax treaty purposes. Article 30 (4) provides that if a French partnership, which is a French resident, benefits from a tax treaty exemption or reduction of tax in the UK, the UK may still tax its UK members on their income or gains arising in the UK.
iv) Members of a third State resident partnership
Another provision of the new treaty deals with partnerships, which are non-resident in one of the contracting states. Under article 30(2), where a resident of a contracting state is a member of a partnership the place of effective management of which is situated in a third state and his share of the income or gains of the partnership is taxed in that contracting state in all respects as though that income or those gains had been derived directly by him, the benefits of this convention may be extended to him with respect to his share of such income or such gains arising in the other contracting state as though he had derived such income or such gains directly. This treatment will be subject to such conditions as the competent authority of that other state may determine having consulted the competent authority of the first mentioned state. In practice, for example, if a UK resident receives French royalties through a Canadian partnership, no withholding tax will be levied in France.
v) Professional partnership
The current position of the French tax administration is that the French partners (e.g. French solicitors) members of a UK partnership are not taxable in France on the income from the UK partnership, but such income is taken into account in the determination of their progressive income tax rate.
Under a strict application the new article 30 on the partnership, the French partners should become taxable in France on the UK income source with a tax credit equal to the UK tax.
However, our analysis of the exchange of notes (in relation to article 30) annexed to the new tax treaty is that "a partnership which is not resident of a Contracting State" includes not only a partnership located in a third party country but also a partnership located in the UK. This interpretation is supported by the paragraph 2 of article 30 of the exchanges of notes, which refers directly to "partnership whose place of effective management is situated in a third party".
Consequently the French permanent establishment or fixed base of a UK partnership, e.g. a lawyer in partnership, will be regarded as a permanent establishment or fixed based of each member of the partnership who is entitled to the benefits of the convention. This article leads us to consider article 15 (independent personal services), which triggers a taxation of the personal services in France. However in that case, article 25(3)(a)(i) allows the offset of a tax credit equal to the amount of French tax attributable to such income. Thus it is arguable that the new treaty will not adversely affect professional partnerships in the way feared by many commentators.
3. Investments funds
The new treaty also creates benefits for "investment schemes" established in the UK that invest in French resident companies. An "investment scheme" established in the UK is defined in article 31(6)(a) of the new treaty as a "collective investment scheme within the meaning of the Financial Service Act 1986 and of the Financial Services and Markets Acts 2000 of the United Kingdom (other than a charitable unit trust scheme or a limited partnership scheme)."
Under articles 31(1) and 31(2) of the new treaty, such an "investment scheme" will be eligible for the benefits of the new treaty with respect to dividends and interest arising in France, but only up to the amount of those dividends or interest that are beneficially owned by UK residents, in the case of investment programs that are not subject to income tax in the United Kingdom. This means, for example, that dividends and interest arising in France and received by such an investment program may be subject to reduced French withholding tax at the rates of 15% (instead of 25% under French domestic law) and 0% (instead of 16 % under French domestic law) respectively.
4. Corresponding adjustments on transfer pricing
Article 10 of the new treaty covers associated enterprises dealing between themselves other than at arm's length. The first provision of the article, as under the current treaty, provides, in substance, that where an enterprise of a contracting state deals with an associated enterprise in the other contracting state other than at arm's length, then the profits of that first enterprise may be deemed increased and taxed accordingly. However, the new treaty goes on to provide for the other contracting state to make "an appropriate adjustment" to the amount of the charge taxed on the associated company, with the competent authorities of the two contracting states liasing with each other to that effect if necessary. Importantly, the new treaty, but not the OECD model provides for the corresponding adjustment to be made "where that other state considers the adjustment justified", which adds a supplementary condition to the entitlement to adjustments and could conceivably lead to difficulties in practice.
5. Capital gains
i) Regarding capital gains on real estate, the new treaty spells the end of a current tax advantage.
Under the current treaty, capital gains realised by a French resident on disposal of UK real estate are exempt from tax in France and are only taxable in the UK. Yet, there is no tax on capital gains realised by a non-resident in the UK. Therefore, in practice no tax is triggered in either country on UK real estate profits.
The new treaty provides that the capital gains on real estate are taxed in France and in the UK with a tax credit in France equal to the UK tax i.e. nil in this case. Consequently, capital gains on the disposal of UK real estate realised by a French resident will become fully taxable in France.
ii) More favourably however, and as an improvement to the current treaty, the new treaty does not provide for the taxation of the disposal by a UK person of a substantial participation (i.e. more than 25%) in a French company. Combined with the taper relief in the UK, this provides an advantage for UK personal investment in France.
6. Application of French CFC and thin cap rules
There are no provisions in the current treaty in which France expressly reserves the right to apply its Controlled Foreign Company (CFC) rules (article 209 of the French Tax Code) to UK subsidiaries of French parent companies. Article 25(3)(a) of the new treaty includes a new provision stating that "notwithstanding any other provision in the convention, income which may be taxed or which may be taxed only in the United Kingdom in accordance with the provisions of this convention, shall be taken into account for the computation of the French Tax where such income is not exempted from corporation tax according to French domestic law". The effect of that provision, according to the French tax authorities, will be to allow France to apply its CFC rules. However, the French Supreme Court considers that, unless there is an express mention in a tax treaty, article 209 B of the French Tax Codes violates article 7(1) of the OECD model treaty (similar to article 7(1) of the new treaty).
That said, the new French Finance Act for 2005 should end this debate, as it should introduce a new provision making the CFC rules no longer apply if the entity is located in a EU country (except where there is artificial financing in order to avoid French legislation).
Similarly, while there are no provisions in the current treaty in which France expressly reserves its rights to apply its thin capitalization rules (as set forth in article 212 of the French Tax Code) to French subsidiaries, article 26(6) of the new treaty provides that nothing in the convention should restrict France from applying article 212 of the French Tax Code, or any substantially similar provision amending or replacing this article. However, in two recent cases (CE SA Andritz, 30th December 2003, and CE SARL Coréal Gestion, same date) the French Supreme Court considered that article 212 is contrary to article 25(5) of the OECD model and to the EU principle of the freedom of establishment. This casts considerable doubt on whether the new treaty will allow France to apply article 212.
Individuals
1. Limitation of the remittance basis rule
According to article 32 of the new treaty, a UK resident, receiving income (except for dividends) or gains from France will benefit from the tax treaty protection only if the income or gains are taxed in the UK.
Under the current treaty, French employees expatriated in the UK, receiving part of their salary in France for their activity in this country, are exempted in France by virtue of article 15-2, i.e. if they spend less than 183 days in France, they do not have a French employer, and their remuneration is not borne by a permanent establishment of their employer in France. This part of their salary is also exempted in the UK under local legislation if they do not remit it.
The new provision of article 32 will mean that they will eventually have to chose between being taxed in the UK when they remit this part of their salary (this part will be exempted in France under provisions of the tax treaty), or to be taxed in France if they do not remit their salary in the UK (and consequently be exempted in the UK under the remittance basis rule).
For capital gains, it appears that in most cases relying on the remittance basis rule should be more advantageous. Thus, under French domestic tax law, non-residents are exempted from capital gains if they sell less than 25% of the shares of a French company, so in this case it is obvious that no remittance to the UK should occur. If the non-residents sell more than 25% of the shares of a French company, they will be taxed in France at the rate of 16%, which should be less than the UK tax rate, unless taper relief reduces the tax rate (to 10% in some cases). Clearly a careful consideration will be required in each case.
2. Director's fees
As under the current treaty, article 16 of the new treaty provides for directors' fees derived by a resident of a contracting state, in his capacity as a member of the board of directors of a company that is resident of the other contracting state, to be taxed in that other state.
However, unfortunately, the new treaty avoids double taxation on directors' fees taxed at source, in the case of French residents, via the credit for "the amount of paid tax in the UK" method i.e. an actual credit method. This means that a French resident being a director of a UK company will become taxable in France on the fees received with a tax credit equal to the tax paid in the UK in this respect. As the rate of taxation of directors' fees in the UK is relatively low, in practice the fees will be totally taxable in France. The current treaty provides for the most favourable method, i.e. exemption in France with progression method and has been used as a tax-planning tool for French resident director in multinational groups.
3. Wealth tax
Under French domestic tax law, French residents are subject to wealth tax on their worldwide assets (non residents are subject to it only on their assets located in France).
Although wealth tax is not generally under the scope of the new treaty, article 32§3 provides that UK nationals (not being nationals of France) coming into France are exempted from wealth tax for 5 years on their assets located outside of France. This exemption can apply again if the UK national loses the status of resident of France for a period of at least three years, and then becomes a resident of France again.
