By Terence Wilhelm, Cara-Avocats, Lyon, France
The governments of France and Luxembourg on March 20 signed a new double tax treaty designed to supersede their current tax treaty, dated April 1, 1958. This new treaty incorporates the latest OECD/G20 base erosion profit shifting (BEPS) initiatives and responds to landmark French case law.
Certain key features make this treaty one of a kind and may shed light on what future tax treaties signed by France may look like.
Recent case law in France has revealed the weaknesses of the current French tax treaty network. France has more than 100 tax conventions in place, with some dating back to the early 1940s when the international tax landscape was very different from what it is today.
Bolstered by the latest BEPS initiatives, the French government has expressed its willingness to profoundly revise its tax treaty network.
Reduction of the personal scope of the treaty
The new France-Luxembourg tax treaty provides for a revised definition of a resident person eligible for tax treaty benefits.
More particularly, the treaty now excludes persons and entities that are not liable to tax in either country. We can find the roots of this new definition in recent case law that rapidly formed precedents in the French tax landscape, such as the LHV and Santander decisions rendered by the French Administrative Supreme Court in 2015 soon after the Indigo-Yacht decision was released by the Administrative Court, to everyone’s surprise.
Under the treaty, taxpayers not paying taxes in either country either because they fall out of the ambit of the tax at stake or by virtue of a tax ruling may no longer seek tax treaty benefits.
The most important consequence of this would be that the taxpayer could not initiate the tax treaty’s mutual agreement procedure. In addition, any cross-border transaction subject to reassessment in France would trigger a 33% withholding tax (and not the new reduced withholding tax rate mentioned below).
Permanent establishment definitions
The new treaty’s definition of permanent establishment introduces the criterion of place of effective management as the key element to determine the tax residency of a party and, hence, the potential existence of a fixed place of business operated in the other country.
Here again one will notice the influence of a court decision. The French Supreme Court’s Wagons Lits decision, rendered in 2016, specifically shed light on permanent establishment structures.
Under the new treaty, it will be key to assess where strategic decisions are taken and where shareholders or management meetings take place as this may influence the location of the profit derived by cross-border structures and, by the same token, the corporate income tax rate applicable.
On a separate note, the new tax treaty also provides for a revised and BEPS-compliant definition of permanent establishment.
In light of BEPS Action 7, this change is designed to tackle strategies used to prevent the recognition of a permanent establishment through agency or commissionaire arrangements or the exception applicable to activities of a preparatory and auxiliary character.
OECD-BEPS Action 7 clearly influences this new section. It is interesting to note that only two days after the release of this new version of the tax treaty, the OECD issued additional guidance (link) on the attribution of profits to permanent establishments to add to its recommendations on BEPS Action 7. (https://mnetax.com/new-oecd-guidance-on-attribution-of-profits-to-pes-reflects-beps-changes-26824)
Substance over form
The treaty also integrates changes that clearly aim at correlating the attribution of profit (and hence, the applicable tax regime) to the location of substance.
In this respect, one will note that the new treaty introduces specific anti-abuse rules based on the “principal purpose” test as originally defined by the OECD.
This new provision reflects BEPS Action 6 which specifically aims at preventing the granting of tax treaty benefits when the circumstances are inappropriate. Under this test, treaty benefits shall not be granted if it is reasonable to conclude that obtaining that benefit was one of the principal purposes of any arrangement or transaction concluded between the parties, unless it is established that granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the treaty.
In a similar manner, the new version also introduces the concept of “beneficial ownership” with respect to dividend, interest, and royalty income for purposes of eliminating the avoidance of withholding taxes.
The objective here is to avoid the misuse of corporate vehicles for illicit purposes. This new concept echoes the EU Anti-Money Laundering Directive that was introduced into the French landscape in August 2017. As a reminder, French companies need to register the beneficial owners of said companies no later than April 1.
New rate for withholding tax
Finally, the treaty introduces a dividend withholding tax exemption applicable to distributions paid from a corporation liable to tax, when the beneficial owner is another corporation that owns directly at least 5 percent of the share capital of the distributing corporation for a period of 365 days, including the dividend payment date.
Under the current 1958 France-Luxembourg tax treaty, a withholding tax of 5% or 15% applies to cross-border transfers of dividends. The rate varies depending on the percentage of shares owned.
Transfer pricing deemed dividends
Transfer pricing reassessment usually involves distributions of deemed dividends. This treatment was approved by the French tax court.
Under the current tax treaty, transfer pricing reassessment involving French and Luxembourg transactions triggers a 5% to 15% withholding tax, on which is applied interest for late payment and a 10% penalty for failure to declare said withholding tax on time.
Under the newly signed France-Luxembourg tax treaty, tax reassessment arising from transfer pricing may give rise to 0% withholding tax (assuming one party owns more than 5% of shares in the other party’s capital).
This exemption is limited to a very small number of French tax treaties besides the newly signed treaty.
France-Luxembourg tax treaty application
The newly revised tax treaty could enter into force as early as January 1, 2019.
In the meantime, we recommend the companies with cross-border structures not wait to consider these changes in their operational and tax strategies.
This new tax treaty likely also shows what future tax treaties signed by France will look like as several French treaties are expected to be redesigned or amended.
–Terence Wilhelm is an Attorney at Law, PhD, and the managing partner of CARA Avocats, a law firm dedicated to tax and transfer pricing in France. He can be reached at [email protected] or +33 4 72 20 12 88.
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