This new DTT with France is fully “post-BEPS”. It implements the new approaches developed at international level during the OECD/G20 BEPS project, and since reflected in the 2017 version of the OECD Model Tax Convention (“the 2017 OECD Model”), and in the Multilateral Convention to Implement Tax Treaty Related Measures (“the MLI”), signed by both Luxembourg and France in June 2017, and also since ratified by both countries.
More specifically, the DTT redefines what constitutes a permanent establishment for the purposes of the DTT, and introduces new rules for the taxation of cross-border payments such as dividends, interest and royalties. The Protocol clarifies and potentially changes the situation of cross-border workers, and grants limited access to the DTT to Undertakings for Collective Investments (“UCIs”).
France has already ratified the DTT, with the approving vote in France’s Assemblée nationale having taken place on 14 February 2019. Hence, assuming that the exchange of the instruments of ratification between Luxembourg and France takes place during 2019 (as is now highly likely), this new DTT will largely enter into effect on 1 January 2020.
The three other double tax treaties or protocols ratified were the new double tax treaty with Kosovo (which largely follows the 2017 OECD Model), a protocol to the treaty with Uzbekistan (adding the “principal purposes test” entitlement to benefits article of the 2017 OECD Model), and an amending protocol to the treaty with Belgium.
This amending protocol formalises the position of workers crossing the border between Belgium and Luxembourg, who for treaty purposes are to be regarded as carrying out their employment exclusively at their normal place of work, unless they spend more than 24 working days in a tax year physically working in their country of residence or in a third country. The amending protocol does not change the situation of these cross-border workers, as the rules laid down in the amending protocol are in effect the same as those already applying since Luxembourg and Belgium entered into a Mutual Agreement on this matter on 16 March 2015.
The text of the DTT as ratified does not differ from the text signed by the two countries in March 2018. The notes below summarise the principal and most notable provisions.
The form and text of the new DTT mostly follow closely the wording of the 2017 OECD Model, and the MLI. All Articles in the new DTT correspond to the equivalent Articles in the 2017 OECD Model. The title and preamble mirror the “post-BEPS” wording of the 2017 OECD Model, emphasising that the purpose of the treaty includes the prevention of tax evasion and avoidance, and the targeting of treaty-shopping arrangements. In this context, the new DTT includes, as its “Entitlement to Benefits” Article 28, the “Principal Purposes Test” (“PPT”) wording effectively identical to that of Article 29.9 of the 2017 OECD Model.
However, as might be expected given the common border between the two countries, and the advanced development of financial services industries in both countries, the new DTT also contains a number of specific, “non-Model” provisions.
The concept of “residency” found in the current DTT pre-dates, and is not in line with, that used in the OECD Model. (The current DTT focuses on the concept of managed and controlled entity rather than the tax status of the resident.) The new DTT however does follow the 2017 OECD Model, and defines a resident – and thus a person entitled to access treaty benefits – as a person “subject to tax”.
The clause in this Article of the new DTT that deals with double residence situations concerning legal entities retains the pre-2017 OECD Model approach of looking to the “place of effective management” as the “tie-breaker”. The 2017 OECD Model / MLI new approach, of leaving the “tie-breaker” to be decided by competent authorities, has not been followed: notably, both Luxembourg and France had opted to “reserve” against (and thus not to have to apply) the relevant article of the MLI that would have introduced the new approach.
The new DTT expressly confirms that that French SCIs and some other similar types of entities (each subject to tax in France, but for which investors are personally liable for taxes) are considered as “resident” in France in the meaning of this DTT.
Conversely, and disappointingly, the new DTT does not follow the 2017 OECD Model in confirming explicitly that “recognised pension funds” are to be regarded as residents for DTT purposes.
In addition, for certain collective investment funds and pension funds, in the light of recent case law by the French Administrative Supreme Court, being “subject to tax” necessitates being in effect being subject to tax without the possibility of any exemption that could be granted by another provision of local law. Tax-exempt vehicles, such as French OPCIs and SICAV Specialised Professional Funds (“SICAV FPS”), or Luxembourg Specialised Investment Funds (“SICAV SIF”) may thus not readily be considered as “residents” in the meaning of the new DTT, although the accompanying Protocol (see below) should still afford a certain measure of treaty access for some such entities.
The new DTT does not diverge from the long-standing principle that profits of an enterprise located in one country are taxable only in that country, except when the enterprise carries out business activities in the other country through a permanent establishment situated there.
The definition of a permanent establishment under the new DTT is in line with recent OECD work, and notably the recommendations made by the OECD Action Plan 7 Final Report (“Preventing the Artificial Avoidance of Permanent Establishment Status”) that have been carried through into the 2017 OECD Model, and the MLI.
In particular, “commissionaire” arrangements are expected to be regarded as permanent establishments of the “principal” enterprise, as are any other arrangements where a party acting in one country on behalf of an enterprise habitually plays the principal role leading to the conclusion of contracts in the name of the enterprise. In addition, a party that acts in a country exclusively or nearly so on behalf of a related party is not allowed to use the “independent agent” let-out from the definition of permanent establishment. The stricter “Option A” of the MLI text has been followed in provisions in the DTT that further restrict the scope of the “preparatory or auxiliary” activity let-outs from the definition of permanent establishment.
Although at the time of signing the MLI, France wished to have this part of the MLI apply to the fullest extent to all its treaties covered by the MLI, Luxembourg did not. Indeed, when signing the MLI, Luxembourg had opted to “reserve” against (and thus not to have to apply) any and all of these measures that re-define the permanent establishment for DTT purposes.
Under the current DTT, dividends paid by a company are subject to withholding tax at a maximum rate of 5%, so long as the recipient is a company resident in the other treaty country, and owning at least 25% of the share capital of the distributing company.
The new DTT improves and amends this rule, granting a full exemption from withholding tax for any holding by a company resident in the other treaty country of at least 5%. However, consistent with the text of the MLI, this exemption is only available providing the holding level has been at or above the 5% threshold for at least 365 days.
For other holdings that cannot qualify for the withholding tax exemption noted above, the treaty rate of withholding tax under the new DTT is 15%, unchanged from the current DTT.
The final part of the wording that defines a “dividend” for DTT purposes has been modified. Under the new DTT, the definition includes any distribution that domestic law assimilates to a dividend distribution. This is notably the case for liquidation proceeds from French companies – these may thus suffer withholding tax under the new DTT. Conversely, Luxembourg law does not generally treat liquidation distributions being made as dividends being paid, and in such cases does not seek to apply any withholding tax under Luxembourg domestic law.
Holdings in French OPCIs
One area in which the current DTT provisions have been of importance is in the context of dividends distributed to a Luxembourg company by an organisme de placement collectif immobilier (“OPCI”) set up in the form of a société de placement à prépondérance immobilière à capital variable (“SPPICAV”). Subject to liquidity conditions, an OPCI established under the SPPICAV form is exempt from French corporate income tax.
Under the current DTT, where a Luxembourg company holds at least 25% of the capital of the French OPCI and receives a dividend from it, the Luxembourg company may suffer French withholding tax at the 5% treaty rate. The dividend is then (see comments below on Article 22) treaty-exempted from any further Luxembourg taxes.
This outcome changes markedly under the new DTT, which contains specific provisions concerning dividends paid out of profits generated from real estate assets.
Under Article 10.6 a) of the new DTT, dividend distributions, which derive from real estate-related income generated by any fund vehicle or company that distributes most of its exempt real estate income and gains on an annual basis, are expressly taxable in the recipient country.
Furthermore, under the new DTT, such dividend distributions will also be subject to much higher withholding taxes. Article 10.6 b) of the new DTT allows a 15% maximum withholding tax rate, but only where the beneficial owner of the dividends holds directly or indirectly less than 10% of the share capital in the fund vehicle.
When the beneficial owner of the dividends holds 10% or more of the share capital of the fund vehicle, under Article 10.6 c) of the new DTT, dividends are not granted any reduced treaty rate of withholding tax. They are thus to be subject to withholding tax at the relevant domestic withholding rate (i.e. 28% in France for 2020, reducing to 26.5% for 2021 and 25% for 2022 – but potentially 15% in some specific cases).
Because the Luxembourg domestic “participation exemption” regime does not in principle apply to holdings in French OPCIs or SIICs (French REITs), this new DTT measure has a significant effect, leaving distributions from French OPCIs or SIICs fully subject to Luxembourg corporate income taxes. However, under the new DTT, a Luxembourg recipient of dividends that is taxable on such income, and where the distribution has suffered French withholding taxes as noted above, should often be in a position to claim a partial tax credit. See further comments below on Article 22.
Cross-border interest payments are to be taxable only in the country where the recipient is a resident. In other words, there is a full exemption from withholding tax. (It should of course be noted that Luxembourg domestic law anyway generally does not impose withholding tax on interest flows.)
This full exemption represents a change from the equivalent provision in the current DTT, which allows withholding tax to be imposed, at a maximum 10% rate.
Consistent with the OECD Model, the Article however goes on to provide that this treaty relief is limited to the “arm’s length” portion of the interest. In other words, in cases where an interest rate is considered to be excessive as a result of special relationships between the parties, the excess part of the interest (compared to the rate that would have been agreed in the absence of any special relationship) remains taxable in accordance with domestic law and other provisions of the new DTT.
Cross-border royalty payments are to be taxable in the country where the recipient is a resident. Such royalties may also be taxed in the source country. However, the taxation is not to exceed 5% of the gross amount of the royalties paid to the recipient. (Under Luxembourg domestic tax law, there is generally no withholding tax on royalty payments).
This 5% rate represents a change from the equivalent provision in the current DTT, which gives a full exemption from withholding tax.
In a manner similar to the anti-avoidance provision applicable to cross-border interest noted above, the new DTT provides that treaty relief is limited to the “arm’s length” portion of the royalties.
Article 13 of the new DDT provides that generally capital gains are to be taxed only by the country where the person disposing of the asset (that gives rise to the gain) is a resident. Exceptionally, capital gains may be taxed in the country where the asset is located, notably in cases where the asset is:
This last provision is broadly consistent with the current DTT, which was only relatively recently amended to bring in this “real estate rich” company measure. (The relevant Protocol was signed in September 2014.) The new DTT however tightens the provision, extending its scope also to cover the situation during the 365 days before the share disposal.
The new DTT is consistent with the text of the MLI concerning “real estate rich” companies. Although at the time of signing the MLI, France wished to have this part of the MLI apply to the fullest extent to all its treaties covered by the MLI, Luxembourg did not. Indeed, when signing the MLI, Luxembourg had opted to “reserve” against (and thus not to have to apply) any and all of the “real estate rich” company measures.
The new DTT introduces a further exception to the general rule that only the country where the owner of the asset is resident can tax a gain arising. This further rule goes beyond the 2017 Model and the MLI, and concerns disposals by individuals of major shareholdings (e.g. in family-owned companies), in cases where the individual making the disposal has migrated from the country where the company is resident to the other treaty country within the previous 5 years. Under the new DTT, capital gains derived by an individual from the disposal of a substantial shareholding (where the shareholder is holding directly or indirectly, alone or together with connected persons, shares or similar instruments based on which the shareholder is entitled to at least 25% of the profits of a company) in a company located in the other country, are taxable in that other country.
The article of the DTT concerning salaries has been completely overhauled, and is now based directly on the OECD Model Article 15 on employment income taxation.
As such, the right to tax employment income derived by a resident of one country from an activity exercised in the other country is taxable in that other country. For example, Luxembourg has the right to tax the salary income of French residents who work in Luxembourg.
However, the new DTT continues to include a frequently relevant exception, included in the 2017 OECD Model and its antecedents, dealing with shorter term secondments of staff and business trips. When the activity is exercised in a country other than the country of an individual’s residence, the right to tax the income remains allocated to the country of residence, although only when the following cumulative conditions are met:
An important “non-Model” measure concerning employees is set out in paragraph 3 of the Protocol to the new DTT, which introduces a derogation from the standard position. Income in connection with days spent “abroad” by a worker (either in the country of the individual’s residence or in third countries, rather than at the usual place of work) remains taxable in the country where the usual place of work is located, provided that no more than 29 days are spent “abroad” during the taxable period. With respect to days spent in third countries, this derogation applies without prejudice to any provisions of the DTT applicable between the country of residence and a third country in which the individual has spent some work days.
In practice, this means that a French tax resident working for a Luxembourg employer is taxable in Luxembourg on the entire amount of his or her employment income, provided that he or she does not work more than 29 days in a tax year outside Luxembourg. At the time of writing, no specific guidance has been given with a view to providing clarity on how this 29-day threshold should be computed.
Similar provisions apply with respect to the DTTs concluded by Luxembourg with both Germany and Belgium. However, the threshold set in the new DTT with France is higher than those applying with Germany (maximum 19 days) and Belgium (maximum 24 days, as noted “In brief” above).
In line with the current DTT’s rules, the new DTT specifies that the right to tax pensions paid under social security legislation (the “first pension pillar”) is given only to the source country.
As regards employer-provided pension plan benefits, the new DTT does not introduce any new provisions. Such benefits remain fully taxable in the country of residence of the recipient, but cannot also be taxed by the source country. Therefore, French tax resident individuals benefiting from a Luxembourg employer-provided pension plan will continue to suffer taxation in France upon receipt of the plan benefits. This is notwithstanding the fact that taxation has, in economic terms, already been levied at source in Luxembourg (20% flat tax payable by the employer at the time of contribution, calculated on employer’s contributions to the pension plan).
In line with the 2017 OECD Model, capital is generally taxable only in the residence country. Notable exceptions include movable property allocated to a permanent establishment in the other country, and real estate located in the other country. It should be noted that the exception does not apply to participations in “real estate rich” entities.
This article remains important as, contrary to most countries, Luxembourg domestic law still imposes a net wealth tax on companies.
The new DTT brings about a major change in the way French tax residents are granted relief from double taxation on income (other than dividends and interest) from Luxembourg. Under the current DTT, such income of French tax residents is relieved from double tax using the “exemption with progression” method. Under this method, “foreign” (in this case, Luxembourg-source) income is tax-exempt, but is nevertheless taken into account in calculating the tax rate applicable to other income in the country of residence (in this case, France) that is taxable there.
However, under the new DTT, the tax “credit” method is to be applicable for all types of income. Under this method, tax is imposed on all sources of income by the country of residence (in this case, France), but the amount of tax that is payable in the country of residence is reduced based on the amount of tax already suffered in the “foreign” (in this case, Luxembourg) country, through the granting of a credit.
Furthermore, the new DTT also provides that, for certain types of income, the tax credit will be linked to the amount of taxes due in France on the same income. In practice, this tax credit method would then produce results that are close to those resulting from the “exemption with progression” method.
Unfortunately, the new DTT is unclear as to which types of income will enjoy a tax credit linked to the amount of taxes due in France, or respectively to taxes due in Luxembourg. In particular, it is not clear at this stage which type of tax credit will apply to employment income, thereby creating a lot of uncertainties for French tax-resident cross-border workers. To date, the French tax authorities have not clarified their position with respect to this question.
For Luxembourg tax residents (both individual and corporate) deriving French source income, the “exemption with progression” method remains applicable under the new DTT for most types of income (i.e. the “foreign” French income is tax-exempt, but is taken into account in calculating the tax rate applicable to Luxembourg taxable income). However, with respect to dividends, royalties, and the income of artistes or sportsmen, which under the new DTT may be taxed in France, the tax “credit” method applies. The tax credit is limited to an amount equivalent to the Luxembourg tax due on that same source of French income.
Also, under the current DTT, within the treaty text rules for eliminating double taxation there has been a specific and explicit “participation exemption” measure, for dividends received from holdings of 25% or more that qualify for the 5% maximum withholding rate. Hence Luxembourg companies receiving dividends from such holdings are currently protected by the DTT from suffering tax on such dividend income, even in cases where the Luxembourg domestic “participation exemption” regime does not result in such an exemption. This special DTT provision aimed at eliminating double taxation has not come forward into the new DTT.
Instead, in cases where a dividend is paid from France to Luxembourg, under the new DTT Luxembourg has the right to tax the income. Luxembourg’s tax regime does, in the absence of specific reliefs and exceptions, tax Luxembourg residents on their worldwide income. Hence this change does represent a significant shift in the balance of taxing rights.
This new provision of course does not preclude the Luxembourg domestic tax regime from granting exemptions from Luxembourg taxes. In particular, in many cases where the dividend recipient is a Luxembourg company, the normal Luxembourg “participation exemption” would still apply.
If Luxembourg however does not exempt the income under its domestic regime, the new DTT should grant a credit for French withholding tax against the Luxembourg tax liability on the dividend flow (even though the new DTT text refers to a “deduction” of French tax paid).
For income arising from French SCIs and some other similar types of entities (each subject to tax in France, but for which investors are personally liable for taxes – see Residence section above), paragraph 5 of the Protocol provides that Luxembourg will grant a tax credit to eliminate any double taxation on income received by a Luxembourg resident via such entities. Comments made during the parliamentary process have however raised several practical issues in relation to this clause, in combination with other provisions of the DTT and/or domestic law.
In line with commitments made within the framework of the MLI (to which, as noted above, both Luxembourg and France are founding signatories), the DTT contains the “Principal Purposes Test” (“PPT”). The wording used in the new DTT is fully consistent with the 2017 OECD Model, and the MLI.
A benefit under the DTT is not to be granted in respect of an item of income or capital, if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining that benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granted that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the DTT.
Paragraph 7 of the Protocol further gives the right to France to apply some of its domestic tax law provisions (articles 115quinquies, 123bis, 155 A, 209B, 212, 238 A and 238-0 A from the “Code general des impôts” or other similar provisions) in a way which over-rides all provisions of the new DTT.
The Protocol gives “undertakings for collective investment” (“UCIs”) limited access to DTT benefits.
UCIs established in Luxembourg or France and assimilated, according to the law of the other country, to UCIs situated there, are to be entitled to the benefits of Article 10 (cross-border dividends) and Article 11 (cross-border interest).
This entitlement is however restricted by an “equivalent beneficiary” type of test, which may give rise to practical difficulties of identification. Treaty benefits are only applicable to the element of these types of income flow that corresponds to rights owned in the UCI by residents of either Luxembourg or France, or by residents of countries that have signed (with the country that is the source of the relevant dividends or interest) a convention on mutual administrative assistance against tax evasion.
On the basis that Luxembourg and France will now proceed to exchange instruments of ratification (and thus cause the new DTT to come into force on the date of such exchange) before 31 December 2019, the provisions of this new DTT will become effective as follows.
For withholding taxes, where the date on which the flow giving rise to the withholding obligation occurs on or after 1 January 2020 (i.e. after the 2019 civil year, this being the year during which the DTT enters into force).
For sources subject to income taxes but not to withholding at source, for the 2020 civil year or tax year (i.e. the relevant year commencing after the 2019 civil year, this being the year during which the DTT enters into force).
For other taxes, for when the triggering event for the tax occurs on or after 1 January 2020 (i.e. after the 2019 civil year, this being the year during which the DTT enters into force).
For withholding taxes, for amounts taxable on or after 1 January 2020 (i.e. after the 2019 civil year, this being the year during which the DTT enters into force).
For income taxes and net wealth tax, for tax years starting on or after 1 January 2020 (i.e. the next tax year commencing after the 2019 civil year, this being the year during which the DTT enters into force).
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