Luxembourg and France have started the ratification process of the new double tax treaty (“DTT”)they signed on 20March 2018. For the new DTT to become applicable as from 2019, the two ratification procedures would need to be finalised and the instruments of ratification exchanged before the end of 2018. What are the chances of this happening in such a short time frame?
On 24 October 2018, France launched the ratification process of the new Luxembourg-France DTT. The French Parliament is expected to vote on the ratification law in December of this year, meaning that from a French perspective, an implementation of the new DTT as from 2019 could be achieved.
As far as the ratification by Luxembourg is concerned, today, the interim1 Luxembourg Government adopted the text of the
draft law ratifying the DTT. It is true that many steps would need to be taken2 within a very short time frame in order for
the new DTT to be applicable as from 2019 and that the Luxembourg future government will also have other pieces of
legislation on its agenda which are high priority (such as the implementation of the Anti-Tax Avoidance Directive) in a
context where a new government is yet to be officially formed following the 2018 October elections. However, one should
bear in mind that ratification procedures can be finalised very quickly since their very purpose is only to approve a text (the
DTT in this case) which is already final as it has already been heavily negotiated by the relevant governments prior to
being approved, and therefore not subject to any amendments, unlike other pieces of legislation.
Therefore, even though the date as from which the new DTT will become applicable still remains uncertain at this stage,
the chances that the new DTTwill be applicable as from 2019 are rather high.
The aim of the new DTT is to replace the existing treaty that was signed in 1958, and amended 4 times in subsequent years. The DTT follows the structure and, for the most part, the content of the 2017 OECD Model Tax Convention.
Given the significant changes introduced, especially for real estate investments in France, Luxembourg taxpayers with investments in France or that plan to invest in France should seek advice from their tax adviser as soon as possible in order to analyse the potential impact of the new provisions on their investments.
You will find below an overview of the new DTT and its main provisions.
New Preamble and Principle Purposes Test
In line with the latest version of the OECD Model Tax Convention and the Multilateral Convention to Implement Tax Treaty
Related Measures to Prevent Base Erosion and Profit Shifting ("Multilateral Instrument" or "MLI"), the following preamble
has been included in the DTT: the aim of the DTT is the elimination of double taxation with respect to taxes on income and
on capital while guarding against situations of non-taxation or reduced taxation through tax evasion or avoidance (including through treaty-shopping arrangements).
In addition, in order to address some forms of treaty abuse, the DTT contains a principal purposes test (“PPT”) in accordance with Actions 6 and 15 of the Base Erosion and Profit Shifting (“BEPS”) Action Plan, and in line with the guiding principle of paragraph 9.5 of the Commentary included in 2017 OECD Model Tax Convention. Under this PPT, a DTTbenefit will be denied if it is reasonable to conclude that obtaining that tax benefit was one of the principal purposes of anyarrangement or transaction (subjective test). However, DTT benefits will still be granted if it can be demonstrated that granting such benefits, in the circumstances at hand, would remain in accordance with the object and purpose of the relevant provisions of the DTT (objective test). Given the complexity in interpreting and applying this provision which will have to be read in conjunction with EU law (as defined at several occasions by the Court of Justice of the EU), it isrecommended to seek advice from a tax adviser when setting up cross-border investments.
Persons Covered and Tax Residence
As far as persons covered are concerned, tax transparent entities (partnerships) are excluded from the qualification of person for DTT purposes. Nevertheless, the DTT could be applied to either France or Luxembourg source income derived through a transparent entity located in Luxembourg or in a third State having concluded with the source State a convention on administrative assistance, subject to the condition that the tax transparent treatment of the partnership is also recognised by the third State. French partnerships subject to tax in France are excluded from this provision and are treated as tax residents of France for the purpose of the DTT.
As far as tax residence is concerned, the DTT amends the existing rules applicable in cases of conflict of company
residence and provides that a company is considered as resident in the State in which its effective place of management
Application of some DTT provisions to Collective Investment Vehicles (“CIVs”)
Contrary to the current version of the tax treaty, the DTT expressly states (in its Protocol) that it will apply to CIVs under certain conditions. This approach is notably compliant with the OECD report “The Granting of Treaty Benefits with Respect to the Income of Collective Investment Vehicles”. The Protocol to the DTT provides that a CIV established in a Contracting State, to the extent it is assimilated to a CIV under the legislation of the other Contracting State, may be granted some of the DTT benefits under certain conditions. The CIV (e.g. a Luxembourg SICAV or SICAF) will be able to claim the benefits under articles 10 (dividends) and 11 (interest) in order to benefit from the reduced withholding tax (“WHT”)rates on dividends and the exemption of WHT on interest, but only up to the portion of the units/shares held in the CIV by “good” or “qualifying” investors. “Good investors” are defined as investors resident in a country which has concluded a convention on administrative assistance in order to fight against tax fraud and tax evasion with the country in which the CIV invests.
The DTT gives no indication as to the practical application of these conditions (how to calculate the portion of good
investors? at what moment? etc.). Therefore, this provision seems very difficult to apply practically for CIVs, especially for
those held widely and/or for open-ended CIVs.
The definition of permanent establishment set forth in the DTT is fully based on the BEPS definition. In this respect, the
definition generally corresponds to the position taken by France and not to the one that Luxembourg defended, notably in
relation to the MLI. As a result, (1) the qualification of “dependent agent”is extended, (2) the scope of the preparatory and auxiliary activities exemption is based on a lighter BEPS option, (3) the anti-fragmentation rule which limits the preparatory and auxiliary exemption scope is introduced and, (4) anti-abusive splitting-upof contracts for construction site period computation
purposes is also added.
Under the DTT, dividends will be subject to a WHT of maximum:
- 0% if the beneficial owner is a company which directly holds at least 5% (previously 25% under the current DTT, but 10% under the EU Parent Subsidiary Directive) of the capital of the paying entity for a period of 365 days, including the day of the dividend payment;
- Domestic rate (currently 30% in France) if the dividend is paid out of tax exempt income or gains derived from immovable assets by an investment vehicle, established in a Contracting State, which distributes annually most of its income, if the beneficial owner of the dividend is resident in the other Contracting State and holds, directly or indirectly, a shareholding of 10% or more in the share capital of the investment vehicle;
- 15% in all other cases (including in cases where the beneficial owner of the dividend paid by the real estate investment vehicle described above, holds a participation of less than 10% in this vehicle).
The aim of this provision is specifically to make sure that dividend distributions by French OPPCI and SIIC are subject to a
WHT of either 15% or 30%, depending on the shareholding held by the Luxembourg resident company. This change will
incontestably impact real estate investments made by Luxembourg companies in France.
Interest and royalties
Interest will only be taxable in the country of the recipient, and thus cannot be subject to WHT in the source country. This
was already the case under the previous DTT and is currently not particularly relevant given that both countries do not levy
WHT on arm’s length interest under their internal law.
Royalties which are taxable in the country of the recipient could also be subject to a WHT of maximum 5% in the source
country, which is correspondingly the rate applicable under the previous DTT.
Capital gains & real estate rich companies
In principle, gains derived from the alienation of movable assets are taxable in the Contracting State of residence of the
The new DTT slightly amends the specific provision applicable since 2017 (based on the 2014 Protocol) to capital gains realised on the sale of real estate rich companies. The change introduced in the DTT relates to when the 50% threshold of real estate assets needs to be assessed.
According to the amended provision, capital gains derived by a resident of a Contracting State from the alienation ofshares and similar rights in a company, deriving directly or indirectly more than 50% of its value from immovable property situated in the other Contracting State at any time during the 365 days preceding the alienation, may be taxed in that other State. As under the current provision, the rule applies to shares or other rights held both in a company resident in one of the Contracting States and in a company resident in a third country.
The DTT also introduces a rule according to which gains derived by an individual resident in one of the Contracting States
from the alienation of a substantial shareholding (i.e. a direct or indirect shareholding giving rights to at least 25% of the profits of the company) in the share capital of a company resident in the other Contracting State are taxable in this Contracting State and not in the residence State of the alienator if the individual was resident of the other Contracting State at any time during the 5 years preceding the alienation of the shareholding. It appears to us that the compatibility of this rule with some European fundamental rights could be challenged.
As far as employment income is concerned, even though the rule has been redrafted to follow the OECD Model Tax Convention wording, the rule remains that income derived by a resident of a Contracting State from employment shall be taxable only in that State, unless the employment is “effectively” exercised in the other Contracting State.
In other words, a French tax resident employed by a Luxembourg employer is taxed in Luxembourg on his or her employment income, but only to the extent that the work is effectively performed in Luxembourg.
Here, it is worth mentioning that the situation of cross-border workers will change slightly due to the fact that the residence State of the employee will not be able to challenge the taxation of the salary in the State of the employer as longas the number of days spent by the employee outside of the employment State does not exceed 29 days per year. While this may appear to be good news at first sight for French cross-border workers, it seems that in certain cases, the current practice of the French tax authorities has been even more flexible: in 2012, while responding to a parliamentary question, the French Minister of Economy mentioned that a French employee of a Luxembourg company would remain taxable in Luxembourg on his or her salary to the extent that the employee did not spend more than one day per week (i.e.approximately 50 days per year) working in France.
As far as pensions are concerned, pensions paid out of a compulsory social security system will generally be taxed in the
Methods to avoid double taxation
France generally applies the credit method, with certain limits, to avoid double taxation. The benefit of a tax credit corresponding to the French tax for a French resident is subject to an effective taxation in Luxembourg. Luxembourg generally applies the exemption method. However, the credit method applies to dividends, royalties and income of artists and sportsmen.
Entry into force
As already mentioned, the new DTT will enter into force as soon as France and Luxembourg have exchanged the instruments of ratification, following the ratification procedure in their respective countries.The new DTT will apply totaxes in relation to the calendar year following the entry into force of the treaty, i.e. to taxes in relation to the tax year 2019 at the earliest.
A newsflash will be sent as soon as the ratification procedures are finalised in both France and Luxembourg.
1Following the elections which took place on 14 October 2018, an interim Government has been set up, pending the final coalition agreement to be reached and the new government to be formed.
2i.e. draft law presented to Parliament; draft law commented by the chambers and State Council; report of the Budget and Finance Commission of the Luxembourg Parliament released, first parliament reading, dispensation from a second parliamentary reading granted by the State Council, publication of the ratification law in the Memorial and finally exchange of the instrumentsof ratification.