A new double tax treaty (the Treaty) between France and Luxembourg was signed during a State Visit in Paris on 20 March 2018. Once in force and effective, the new treaty will replace the old France-Luxembourg Income Tax Treaty (1958).
For Luxembourg and France, the Treaty should be applicable to taxable income incurred as from January 1st of the year immediately following the year during which both jurisdictions will accomplish the ratification process. Assuming that the Treaty is enacted in the course of 2018, it will be applicable as from 1 January 2019 onwards.
The Treaty follows the 2017 update of the OECD Model Tax Convention that comprises changes approved as part of the Base Erosion and Profit Shifting BEPS Package, or which were foreseen as part of the follow-up work on the treaty-related BEPS measures. It includes options chosen by Luxembourg and France on the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (the MLI), the main purpose of which is to enable countries to meet the Treaty-related minimum standards, as well as certain alternatives or optional provisions that were agreed as part of the final BEPS package. It is also in line with the reservations made by both jurisdictions.
The present summary provides an overview and brief explanation of the main relevant changes.
Persons covered (article 1)
The Treaty includes the new paragraph 2 into Article 1 (the transparent entity provision), which is in line with the recommendation of Chapter 14 of the Report on BEPS Action 2 (Neutralising the Effects of Hybrid Mismatch Arrangements). The aim is to ensure that income of such entities or arrangements are treated in accordance with the principles reflected in the 1999 report of the Committee on Fiscal Affairs entitled “Application of the OECD Model Tax Convention to Partnerships” that provides guidance and examples of how the provision should be interpreted and applied to various situations. It however explicitly excludes income derived by (or through) certain French fiscally transparent entities.
It however explicitly excludes income derived by (or through) certain French fiscally transparent entities.
Resident (article 4)
The notion of appearing beneficiary (as for instance a trustee or fiduciary) has been introduced. Indeed, paragraph 5 expressly foresees that appearing beneficiaries are not considered as residents of a Contracting State even if they meet the definition. The appearing beneficiary is defined as a person that appears to be the beneficiary of income, while in reality such income belong directly or indirectly, to a person who cannot be considered as a resident of either France or Luxembourg. To a certain extent, this new anti-conduit provision is innovative and goes beyond the final BEPS Package. It adds another layer of requirements to the well-known concept of beneficial owner contained in other articles of the Treaty.
Permanent Establishment (article 5)
It now includes changes to the definition of permanent establishment in the OECD Model Tax Convention to address strategies used to avoid having a taxable presence. These changes aim at ensuring that when the activities an intermediary exercises in a country are intended to result in the regular conclusion of contracts to be performed by a foreign enterprise, said enterprise will be considered as having a taxable presence in that country, unless the intermediary is performing these activities in the course of an independent business. 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)
With respect to dividends, a 0% withholding tax rate is now foreseen when the beneficial owner is a resident company of a Contracting State that holds directly at least 5% of the share capital of the company that is paying the dividend during a period of 365 days (inclusive of the dividend payment date).
It is interesting to note that upon entry into force of the Treaty, dividends paid out of income derived from immovable property by certain French investment vehicles (eg, French OPCIs) that i) distribute most of this income annually, and ii) whose income and gains derived from immovable properties are exempt from taxation in France, are now taxable in Luxembourg, while up until today these were often exempt under certain conditions (25% holding threshold). The elimination of the double taxation is achieved through the credit method.
France will be allowed to withhold a 15% withholding tax when the resident of Luxembourg who is the beneficial owner of the dividend holds less than 10% of the capital of said investment vehicle. When the 10% or more threshold is met, the French domestic provisions will apply (ie, 30% in 2019, 28% in 2020, 26.5% in 2021 and 25% as from 2022 onwards).
In all other cases than those referred to above, a 15% withholding tax will apply.
Interest (article 11)
While under the old treaty a 10% withholding tax was foreseen, withholding tax on interest is no longer foreseen under the new Treaty.
Royalties (article 12)
The new Article 12 now provides for a 5% withholding tax on royalties payments in the payer jurisdiction even though the OECD Model Tax Convention does not contain such possibility. As of today, Luxembourg does not levy any withholding tax on royalties under its domestic legislation. In addition, the new paragraph 6 of said article introduces the possibility to consider the royalties payment from a permanent establishment located in one or the other jurisdiction as the source jurisdiction of the royalties.
Capital gains (Article 13)
Gains deriving from the alienation of shares or comparable interests, such as interests in a trust, should be taxed in the other Contracting State if, at any time during the 365 days preceding the alienation, these shares or comparable interests derived more than 50% of their value directly or indirectly from immovable property located in that other Contracting State. The above period of 365 days, which was not applicable under the old treaty, is in line with the OECD Model Tax Convention.
With the exception of the right to tax capital gains on real estate asset rich companies, the old treaty generally granted the exclusive right to tax capital gains to the jurisdiction of the seller. The Treaty now foresees that under specific circumstances, capital gains derived by individuals could be taxable in the country of residence of the sold entity. Indeed, capital gains derived by an individual from the alienation of shares or comparable interests qualifying as substantial participation, (ie, giving right, either directly or indirectly, to at least 25% of the profits) held in a company, resident in the other Contracting State, are taxable in that other Contracting State but only to the extent that the seller resided in that other Contracting State at any point in time during the last 5 years preceding the alienation.
This latter provision is well-known under Luxembourg domestic tax legislation as an anti-avoidance rule, aiming at preventing an individual to change its tax residency for the sole purpose of selling its participation while escaping being taxed on the gain.
Income from employment (article 14 and Protocol to the Treaty)
In view of France and Luxembourg being neighboring countries, the Protocol to the Treaty clarifies certain taxation rules applicable to cross-border workers deriving income from employment. Indeed, the Protocol to the Treaty includes a 29-day tolerance regarding the taxation of income incurred on days physically worked outside the State of employment. As is most often the case, a French resident employed by a Luxembourg employer will remain taxable in Luxembourg on his/her entire employment income provided he/she works less than 29 days outside Luxembourg during a calendar year. Conversely, should the employee work 30 days or more abroad during a calendar year, the remuneration in relation to these non-Luxembourg working days will become taxable in France.
Entitlement to Benefits (article 28)
In line with the choices made by France and Luxembourg under the MLI, the Principal Purpose Test (PPT) provision has been included in the Treaty.
Undertakings for Collective Investment (Paragrah 2 of the Protocol to the Treaty)
The Protocol to the Treaty extends the benefits of articles 10 and 11 dealing with dividends and 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 their own UCIs.
The Treaty is generally in line with the 2017 update of the OECD Model Tax Convention and represents a massive overhaul of the old treaty. It further demonstrates Luxembourg's commitment to compliance with the new international tax standards. Furthermore, the Treaty implies that most structures (in particular, in the real estate industry) from both sides of the border should be carefully reviewed, in order to assess the potential impact of the Treaty going forward.