Tax alert: New France-Luxembourg tax treaty

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        <h3>Update</h3>
        <p>On 02 July 2019, the Chamber of Deputies in Luxembourg voted the Act implementing the new double tax treaty (the DTT) between Luxembourg and France. A request for exemption from the second vote has been submitted. Therefore, should the exemption be granted, the new DTT would then enter into force in 2019 and thus into effect on 01 January 2020.</p>
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Background

This new Treaty would be in line with the previous modifications that have taken place in 2006 and 2014 with a view towards allowing France to recover taxing rights over French real estate investments:

• The 2006 Protocol allows France to have exclusive taxing rights over income and gains on French real estate investments directly held by Luxembourg resident investors.
• The 2014 Protocol allows France to have exclusive taxing rights on gains indirectly realized on French real estate assets through the alienation of shares in Luxembourg entities predominantly holding French real estate assets (excluding properties pertaining to the entity’s business activities, other than rental activities).

These amendments prompted the use by Luxembourg resident entities of French regulated real estate investment funds (Organismes de Placement Collectif Immobilier - OPCIs).

Indeed, OPCIs are exempt from French Corporate Income Tax on real estate profits and gains, subject to certain burdensome distribution obligations.

Additionally, the distributions of dividends by OPCIs to their Luxembourg shareholders holding more than 25% of the OPCIs’ capital are currently subject to a maximum withholding tax rate of 5% (article 8 §2 a) 1. of the current version of the Treaty).

The combination of the French Corporate Income Tax exemption and reduced withholding tax rate allows for very tax-efficient structures that might be substantially affected by this new amendment.

What to expect from this new treaty?

The new Treaty is likely to exclude dividends paid by investment vehicles such as OPCIs from the benefit of reduced withholding tax rates.

Such amendments have recently been introduced in numerous tax treaties or treaty amendments concluded between France and the United Kingdom (2008), Panama (2011), Andorra and China (2013) as well as Germany and Singapore (2015).

The model revised dividend provision excludes the dividends paid by French real estate investment vehicles from treaty benefits as follows:

“The provisions [pertaining to reduced withholding tax rates] shall not apply to dividends paid out of income or gains derived from immovable property […] by an investment vehicle:

• which distributes most of this income annually, and
• whose income or gains from such immovable property are exempted from tax

where the beneficial owner of those dividends holds, directly or indirectly, 10 per cent or more of the capital of the vehicle paying the dividends. In such case, the dividends may be taxed at the rate provided for by the domestic law of the Contracting State in which the dividends arise”.

If a comparable provision was to be implemented, the dividends paid by a French OPCI to a Luxembourg holding company holding more than 10% of its shares may be subject to the standard French withholding tax rate:

• 30% until 30 December 2019
• 28% between 01 January 2020 and 31 December 2020
• 26.5% between 01 January 2021 and 31 December 2021,and
• 25% as from 01 January 2022.

How will investors be impacted?

Investors who structured their French real estate investments using French OPCI held by a non-regulated structure based in Luxembourg will be affected by this new development as they should suffer a significant increase of their French withholding tax charge.

Conversely, investors using Luxembourg regulated investment vehicles should not be harmed by this additional treaty amendment/new treaty: irrespective of Treaty provisions, dividends paid by French OPCIs to certain types of Luxembourg qualifying investment funds are subject to a French withholding tax rate of 15%.

These qualifying funds are:

• UCITS under the UCITS IV Directive
• UCITS-like AIFs
• AIFs open to non-professional investors other than UCITS-like AIFs
• AIFs open to professional investors and under certain conditions to non-professional investors
• AIFs equivalent to SICAFs incorporated under French law, and
• AIFs equivalent to OPCIs or professional OPCIs established under French law.

This means that Luxembourg qualifying funds that were generally unable to benefit from the reduced 5% rate under the Treaty will avoid the effects of the contemplated amendment/new treaty by remaining subject to the 15% withholding tax rate.

As for other types of investors, it is expected that French Tax Authorities will examine with particular attention all reorganizations taking place before the possible implementation of the new provisions.

The French Tax Authorities announced such particular scrutiny when the 2006 Protocol was signed and subsequently challenged reorganizations on the grounds of the abuse of law doctrine.

The approach of the French Tax Authorities was in several iterations followed by the administrative panel in charge of abuse of law cases as well as the Conseil d’Etat.

All reorganizations that are not supported by an economic, organisational or financial rationale may be considered as abusive.

When could these change enter into force?

The Luxembourg government has announced, without confirming the exact extent of Treaty changes, that a new version treaty will be signed during the State visit of the Grand-Duke of Luxembourg in France, between 19 and 21 March 2018.

A ratification process will ensue.

The revised Treaty will first be ratified by the French Parliament. Once the revised Treaty has been ratified both in France and Luxembourg, both States will exchange the ratification instruments and the treaty will enter into force between its parties.

Still, the revised Treaty will only have legal force towards French taxpayers as from the date of its publication in the French official gazette.

Generally, new treaty provisions have a deferred date of entry into force and are applicable as from 1st January of the year following the ratification procedure. However, the date of entry into force might differ in the case at hand.
It is expected that French Tax Authorities will push to get the new version of the Treaty to be ratified swiftly so as to apply the new withholding tax rate without delay.

Indeed, with respect to withholding taxes, the French practice is to set the entry into force of new treaties/protocols as from the date of their entry into force in France (that is to say, the date of publication in the French official gazette). This is due to the fact that the applicable withholding tax rate is the one in force as at the date of payment of the taxable distribution of dividends.

It follows that the new Treaty provisions could enter into force without much delay, provided that the schedule of ratification in France in Luxembourg allows for a quick ratification process.