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Impact and Uncertainties of the New France-Luxembourg Double Tax Treaty on Real Estate Investment Structures

Alternative Universe

Authors: Joao Almedia, Aurelien Dorchies

On 20 March 2018, the governments of Luxembourg and France signed a new double tax treaty and its additional protocol (hereinafter together referred to as “the new DTT”) to replace the 60-year-old agreement between the two countries. The new DTT is part of the governments’ desire to modernize its treaty network to include the provisions that reflect the latest OECD standards (2017 OECD Model Tax Convention), including BEPs recommendations and its wording gets closer to the wording of the Multilateral Convention to implement Tax Treaty Related Measures (the “MLI”). The new provisions entered into force from 1 January 2020.

Several provisions of the DTT are impacting regulated and unregulated real estate investment vehicles, notably those involving French OPCIs and French Partnerships such as SCI/SNC. This is particularly as a result of the new provisions regarding the persons covered, the withholding tax rate on dividends paid by real estate investment funds and the method to be used to eliminate double taxation (i.e., the credit method).

In this article we mainly focus on provisions that are expected to have the most significant impact on real estate investments.

Withholding tax on dividends paid by a French Real Estate Investment vehicles

The main amendment concerning the real estate industry affects payments of dividends by French “Organismes de Placement Collectif Immobilier” (“OPCI”) and French “Sociétés d’Investissement Immobilier Cotée” (“SIIC”).

If article 10 does not expressly mention the French OPCI and the SIIC, it clearly affects them. A specific provision states that the dividends paid from income and gains in relation to real estate assets by an investment vehicle established in a contracting state that annually distributes most of its income, and which income and gains derived from real estate assets are exempt from tax, to a resident of the other contracting state, are taxable in this last contracting state. Therefore, dividends received by a Luxembourg tax resident company will be fully subject to tax in Luxembourg. Any withholding tax (“WHT”) should however be creditable in Luxembourg based on the elimination of double taxation provisions of the new DTT.

In addition, the source state may also tax the gross amount of the dividends paid up to a maximum of 15 percent if the beneficial owner is a resident of the other contracting state and directly or indirectly holds a shareholding representing less than 10 percent of the share capital of this investment vehicle.

In case the beneficial owner is a resident of the other contracting state and directly or indirectly holds a shareholding representing 10 percent or more of the share capital of this investment vehicle, the domestic tax rate of the source country applies. This means in the case of a French OPCI/SIIC held by a Luxembourg resident for more than 10 percent that dividends should be taxed at a current domestic WHT rate of 28 percent (fiscal year 2020) in France.

As a result of the above, further to the entry into force of the new DTT, any dividend distributed by French OPCI and French SIIC to Luxembourg tax resident entities should now be subject to WHT in France at the domestic tax rate of 28 percent instead of the 5 percent WHT applicable under the old version. In addition, dividends received by the Luxembourg entity should no longer give right to an exemption in Luxembourg; instead, dividends received should be taxable but benefit from a tax credit applicable against Luxembourg CIT only (i.e. excluding MBT). The switch from exemption method to tax credit also implies that the impact of the interest limitation rules, transfer pricing regulations, and the EU blacklist would need to be considered on investments financed by debt.

The 28 percent domestic rate of WHT on dividends paid out of France is reduced under French domestic law to 15 percent where the dividend is paid by a French investment vehicle, including OPCIs, to certain types of Luxembourg qualifying investment funds such as (but not limited to) alternative investment funds (“AIFs”). In order to determine whether a Luxembourg collective investment vehicle (“CIV”) can be assimilated to a French CIV, a comparability test should be performed based on the guidelines from the French tax authorities in this respect.

Real estate investments through French partnership – French SCI

As opposed to the old version, the new DTT clearly confirms that certain types of French partnerships and some other similar entities which are subject to tax in France, and for which shareholders/members are personally liable for taxes, are considered as “resident” in France in the meaning of the new DTT. This provision specifically refers to French Partnerships which are considered as “translucide” (i.e. semi-tax transparent).

Under the previous DTT, both France and Luxembourg held the right to tax earnings from participations in SCI/SNC. As such, rental income arising from the underlying property (through the SCI/SNC) should have been subject to CIT/MBT in Luxembourg, with a credit for corporate tax paid in France available for Luxembourg CIT purposes. Technically no credit for French CIT should have been available for MBT purposes.

However, by operating this significant change in the characterization of such entities, the new DTT fails to address a number of considerations as highlighted by the Chamber of Commerce during the legislative process and which still require some clarifications to date such as (i) the Luxembourg qualification of “distribution” of income made by French SCI, (ii) the application of the tax credit and (iii) the application of the Luxembourg Net Wealth Tax (“NWT”).

The new treaty is likely to impact many taxpayers investing in French real estate through French SCI/SNC.

Under article 10 of the new DTT, a distribution made by a French SCI should be considered as a dividend distribution. This qualification is made independently of the application of the so-called tax transparency principles to a French SCI. In other terms, Luxembourg has the right to tax such “dividend” distribution, subject to the provision of Article 22, which provides for a tax credit. The protocol further states that in order to eliminate double taxation on income “derived” by a resident of Luxembourg through a French SCI, Luxembourg shall allow a deduction corresponding to the tax paid in France, limited to the amount of tax which would be paid in Luxembourg.

The combination of these provisions reveal uncertainties which could allow for different interpretations. There is therefore a need for clarification.

The treaty does not address the situation where such SNC or SCI is not distributing any income: in the latter case the question is whether Luxembourg could rely on the domestic tax transparency principles in order to not tax the income generated by the French SNC or SCI when it is not formally distributed under corporate law (assuming the income is linked to French real estate) based on article 6 and article 22.

Under this first interpretation supported by reference to the term “derived” ([…]income “derived” by a resident of Luxembourg through a French SCI[…]) used in the Protocol as opposed to the term “distribution”, the domestic tax transparency principle would still be applied. The Luxembourg tax resident shareholder would only tax the income upon formal distribution and a tax credit would be available at that time.

The following practical issues could arise from the above interpretation:

  • Potential timing discrepancy between the fiscal years during which no distribution of income occurred and the subsequent fiscal year where income would effectively be distributed to Luxembourg (Luxembourg would get the right to tax such income with a tax credit despite the fact that the income is originated from real estate in France)
  • Potential losses generated on assets and their tax treatment in Luxembourg (i.e. deductibility)
  • Scope of the tax credit. As mentioned above, the Protocol makes reference to the fact that Luxembourg shall allow as a deduction from the tax on such income an amount equal to the tax paid in France. By opposition to the term used in Article 22 which only refers to tax credit on Luxembourg CIT, does this terminology mean that a credit would also be available on Luxembourg MBT?
  • What would be the level of the formalities/evidence required in order to justify the amount of French taxes to be credited when a dividend is received?

A second interpretation would be to consider that, given the French SCIs translucides are residents in France for the purposes of the new DTT, Luxembourg should also recognize the French tax residency of the SCIs for the application of the DTT. Consequently, the Luxembourg tax resident shareholder would not be taxed in Luxembourg on profits realized by the French SCI which would therefore not be treated as tax transparent. Only dividends distributed by the French SCI to the Luxembourg tax resident shareholder can be taxed by Luxembourg under the new DTT. France holds the right to tax income arising in France through an SCI. As a result of the Protocol, any double taxation should be eliminated at the level of the Luxembourg tax resident shareholder through a tax credit granted over taxes paid in France at the time such income is distributed (particular relevance to the words used in the Protocol versus the wording used on Article 22). This is a new way to apply the credit method taking into account the specific case of the French resident SCIs translucides.

The following practical issues could arise from this second interpretation:

  • Scope of the tax credit as mentioned above
  • NWT: If one were not to recognize the tax transparency of the French SCI in Luxembourg, such shareholding will, in principle, be fully subject to Luxembourg NWT with such shares retained at fair market value. A deduction could however remain available in case the Luxembourg tax resident shareholder is financed by debt. It could indeed be difficult to justify the application of the tax transparency principle for NWT purposes and consider the real estate asset as exempt asset for NWT under the new DTT and consider the French SCI as opaque for CIT/MBT purposes
  • Level of evidence required in order to justify the amount of French taxes to be credited when a dividends is received.

Access to treaty for UCIs  

The Protocol grants access to the new DTT benefits to UCIs subject to restrictions. Indeed, UCIs established in France or Luxembourg and which, according to the law of the other treaty country, are assimilated to UCIs in that other country, will be entitled to the benefits of Article 10 (dividends) and Article 11 (interest) of the new DTT.

However, this will only be the case for the portion of such dividends or interest that correspond to rights in the UCI owned by investors that are residents of France or Luxembourg, or residents of countries that have signed a convention on mutual administrative assistance against tax evasion with the country that is the source of the relevant dividends or interest.

The above could be relevant for French investment vehicles such as an OPCI investing in non-French real estate through a Luxembourg tax resident entity. Under the assumption that a French OPCI would be assimilated to an UCI existing in Luxembourg, and if one combines this article with the provision of article 10, one could reasonably conclude that there would be no WHT on dividend paid by the Luxembourg tax resident entity to an OPCI  - for the portion of such dividends or interest that correspond to rights in the UCI owned by equivalent beneficiary investors - provided the Luxembourg tax resident entity is held for at least 5% over at least 365 days.

Capital gains  

Article 13 of the new DDT extended the real estate rich provision that was part of the 2014 Protocol to include the reference to a 365 days period prior to the disposal.

The changes brought about by the new DTT are applicable not only to new investments but also to existing investment structures. It is therefore highly recommended that investors seek specialized advice in order to evaluate to what extent they may be impacted by these changes and by the evolving tax landscape going forward.

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