New Double Tax Treaty Between Luxembourg and France
On 20 March 2018, France and Luxembourg signed a new bilateral tax convention for the avoidance of double taxation and the prevention of tax evasion with respect to income and wealth tax. Entering the post-BEPS era (OECD Action Plan on Base Erosion and Profit Shifting), the new treaty includes, for instance, the Principal Purpose Test (“PPT”), denying treaty benefits to abusive structures.
The treaty can be applied by individuals and corporations resident and subject to taxation in France or Luxembourg. French partnerships, such as the SCI, subject to taxation, may claim treaty benefits for their own benefit, resulting in reduced withholding tax rates.
Particular emphasis was given by the French negotiators to protect French taxation rights on income derived from real estate situated in France. As a result, under the new treaty, capital gains on the sale of French real estate companies remain taxable in France. The “conventional” route via Luxembourg is hence closed. Furthermore, dividend distributions made by French real estate funds (i.e. “OPCI” and “SIIC”) to Luxembourg mother companies may be subject to dividend withholding tax in France of up to 30% while income may, at the same time, be taxed at the level of the Luxembourg mother company. In such case, French dividend withholding taxes should be creditable to the Luxembourg recipient. The new treaty is less favorable than the existing one, and hence appropriate measures should be taken before the new treaty will enter into force, most likely in 2019.
Dividends paid by a company to a company resident in the other treaty country may be exempt from domestic withholding tax in cases where the recipient has held 5% in the capital of the payer for a period of at least 365 days. These conditions are more favorable than under the existing treaty.
Interest payments are only taxable in the country of the recipient, and hence no withholding tax would be applied (maximum rate under existing treaty: 10%). Royalty payments may be taxed up to 5% in the country of the payer (existing treaty: 0%). The reduced withholding tax rates are subject to the condition that the recipient of the payments is considered the beneficial owner of the payments.
Luxembourg and French investment funds have limited access to the benefits under the tax treaty. Under certain conditions, they can benefit from a reduced dividend withholding tax rate of 15% and an interest withholding tax rate of 0%. The conditions for the limited treaty access are, however, difficult to comply with in practice, and in this regard, further guidance is needed in the future.
Under the new treaty, France applies the credit method on all Luxembourg source income. That means that Luxembourg source income, whether or not subject to taxation in Luxembourg, is subject to taxation in France. Taxes levied in Luxembourg can be credited against the French tax due on that income.
Luxembourg, in contrast, generally exempts French source income in Luxembourg. However, this is not the case with respect to dividends and royalty payments from France taxable at the level of the Luxembourg recipient. French withholding taxes may be credited at the level of the Luxembourg recipient.
The new treaty will enter into force once both France and Luxembourg have ratified the treaty. It is expected that the new treaty will enter into force as of 2019. Until then, the existing treaty still applies. Therefore, investors in French real estate in particular should analyze their investment structure(s) and consider taking action before 2019.