As mentioned in our previous tax alert (Luxembourg Tax Alert 2018-02), Luxembourg and France signed, on 20 March, a new double tax treaty replacing the current tax treaty of 1958 and including the new international tax standards. The text has been published and is available here (pdf 2.15Mb).
This tax alert provides further details on the main tax provisions that may affect Luxembourg corporate taxpayers, in particular those having real estate investments in French SPPICAVs and SIICs, and those carrying out activities in France via agents (in particular investment funds, banks, and insurance companies).
Scope and residents
In the treaty, “residents” now refers to persons who are subject to tax, in line with the new OECD model.
When non-individuals are treated as residents by Luxembourg and France, the treaty foresees that they will be considered resident in the State where they have their effective place of management (in line with OECD model before 2017, the new OECD model proposing a mutual agreement procedure).
Persons such as trustees or fiduciaries that are not the beneficial owner of the income cannot be treated as residents in the sense of the treaty.
French partnerships, groups of persons, and assimilated persons are now expressly treated as being French-resident, provided that their place of effective management is in France, they are fully subject to tax, and they have fully taxable partners in France.
Permanent establishment – definition
The new text completely revamps the provisions on the definition of permanent establishment (PE), which are now in line with the new OECD model, but goes beyond the choices made by Luxembourg in the context of the Multilateral Instrument (MLI).
The most significant change concerns the insertion of the BEPS 7 recommendations on commissionaire arrangements, which have been expanded to include situations in which the dependent agent “habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise.”
The provisions on independent agents have also been expanded: for example, activities of independent agents may constitute a PE in cases where they act exclusively or almost exclusively on behalf of one or more enterprises to which they are closely related.
Furthermore, the treaty includes Option B of the MLI for the specific activity exemption. Thus, certain activities may be carried out in Luxembourg or in France without creating a PE in this country irrespective of whether the activity is of a preparatory or auxiliary character. The treaty now also includes a rule to deal with the fragmentation of activities between closely related parties (an anti-fragmentation rule).
Luxembourg taxpayers (in particular investment funds, banks, and insurance companies) with cross-border activities (and that act via agents / advisory companies) should therefore carefully review their distribution models or the ability of their advisors to negotiate contracts, to avoid the risk of having a permanent establishment in France going forward.
Dividends – withholding tax (WHT)
The new text now provides for an exemption from WHT on dividends, in cases where the recipient is a company and has held a minimum 5% interest in the capital of the company paying the dividends over a period of 365 days. In contrast, the current tax convention only provides for the possibility to reduce the WHT to 5% when the recipient is a company that holds at least 25% of the capital of the paying company.
Undertakings for collective investment (UCIs) established in Luxembourg or in France (although they would not be treated as resident in the sense of the new treaty) may benefit from the treaty provisions on dividends and interests, to the extent that (i) this UCI can be assimilated as a UCI of the other contracting State, and (ii) the beneficiaries of the UCI are residents of one of the contracting States or of a State that has concluded an administrative assistance treaty to combat tax fraud and tax evasion with the source State.
Specific provisions are foreseen for dividends paid by real estate investment vehicles. Based on these rules, French SPPICAVs or French SIICs owned by Luxembourg companies will be subject to a 15% WHT (as opposed to the current 5% which applies under certain conditions) if the Luxembourg resident shareholder owns, directly or indirectly, less than 10% of the SPPICAV/SIIC’s share capital. If the Luxembourg company owns, directly or indirectly, 10% or more of the SPPICAV/SIIC’s share capital, the French domestic WHT would apply (currently 30%).
Elimination of double taxation in Luxembourg
Dividends from shareholdings of at least 25% in French companies will no longer be tax-exempt in Luxembourg under the treaty, but will benefit from a tax credit. Therefore, dividends from shareholdings might only be exempt in Luxembourg in the future based on the Luxembourg domestic participation exemption regime (provided that the conditions are met).
Real estate income and capital gains
The provisions on real estate income and gains do not significantly differ from the current ones and are basically in line with the OECD model. Real estate income remains in principle subject to tax in the source State. The definition of real estate assets has been formalised and refers to the law of the State where the asset is located.
Gains of a Luxembourg- or French-resident investor from the sale of real estate companies (that derive more than 50% of their value directly or indirectly from immovable property located in the other contracting State at any time during the 365 days preceding the sale) are taxable in the other contracting State. The 365-day period is a new element, which is in line with the MLI, although Luxembourg had not chosen this option.
A specific measure has also been added for individuals selling shares of a company that is resident in the other contracting State in which they (the individuals) hold a substantial participation (i.e. direct or indirect participation in 25% of the profits, alone or together with related persons)—the measure only applies if they have been resident in this other contracting State at some time in the previous 5 years.
Frontier workers – taxation of salaried income
Luxembourg will keep its full taxation rights on the salaried income in cases where a French-resident individual working for a Luxembourg employer exercises his/her functions in another State (France or a third State) for a period not exceeding 29 days in total per year. In addition, the treaty specifies that the right to tax statutory pensions (1st pillar) remains with the source State.
However, an important change is expected for French commuters. Contrary to the provisions of the double tax treaties with Belgium or Germany, French-resident individuals will not be exempt in France on their Luxembourg salaried income, but subject to tax there with a credit for the amount of Luxembourg tax suffered.
Anti-abuse rules and the PPT
The treaty now includes the general anti-abuse rule of BEPS Action 6 (the so-called “principal purpose test”), which allows Luxembourg or France to deny a treaty benefit to a taxpayer if obtaining that benefit was one of the principal purposes of the arrangement or transaction, unless it is established that granting that benefit was in accordance with the object and purpose of the relevant provisions of the treaty. This is consistent with the choice made by Luxembourg in the MLI.
Additionally, France will also expressly be able to apply its domestic anti-abuse rules, such as the domestic provisions on controlled foreign companies (CFC), despite any contrary provisions of the treaty.
Entry into force
The treaty will come into force on 1 January of the year following the ratification of the treaty by Luxembourg and France. If the ratification process is completed in 2018, the provisions would therefore apply as of 1 January 2019.
The treaty is (overall) in line with the new OECD model and thus includes some of the BEPS recommendations, showing the commitment of both countries to comply with the new international tax standards.
The treaty now needs to be ratified by both countries for it to enter into force. Assuming both countries ratify the treaty in 2018, its provisions may generally apply as of 1 January 2019.
Taxpayers with cross-border operations in Luxembourg and in France should therefore already assess the potential impact of the treaty on their operations. This will be particularly important for Luxembourg taxpayers (such as investment funds, banks, and insurance companies) performing cross-border activities via local agents, or for Luxembourg companies having real estate investments in France (notably through French SPPICAVs and SIICs). For the latter, our team of tax experts is here to help you assess possible alternatives.
We remain at your disposal to answer any questions on the new treaty provisions.
The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.
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