New tax treaty between France and Luxembourg and the impact on real estate investment in France

The tax treaty in force between France and Luxembourg dated 1st April 1958 was several times amended but was still far from the OECD current international tax standards (the "Former DTT").

France and Luxembourg entered into a new double tax treaty on 20 March 2018 (the "New DTT") which significantly modifies certain attractive schemes including those for real estate investments in France structured with French OPCI.

France and Luxembourg also signed a protocol (the "Protocol") which clarifies the situation of certain collective investment vehicles qualifying as undertaking for collective investment ("UCIs").

The two major changes relate to the definition of tax residency and the taxation on distribution.

A narrow definition of tax residency (Article 4 of the New DTT)

One of the specificity of the Former DTT was that no "subject to tax" condition was provided to qualify as a tax resident. The criteria was to be an entity managed and controlled in one of the jurisdictions. As such, for instance French SPPICAV which are tax exempt OPCI were considered as resident and eligible to the treaty protection.

The new definition of a tax resident requires that the person is subject to tax in France or in Luxembourg as a result of its domicile, residency, place of management or business.

By derogation, certain tax exempt collective investment vehicles established in a contracting State and assimilated by the other contracting State to UCIs will benefit from the provisions of the tax treaty with respect to dividend distributions and interest payments.

In addition, the New DTT expressly indicates that French SCIs which are tax transparent entities but subject to taxes in France at the level of their partners are considered as French tax residents for the application of the New DTT.

A higher taxation on dividend distributions (Article 10 of the New DTT and Article 2 of the Protocol)

In addition to a broader definition of dividends (which will include deemed distributions and liquidation proceeds), the main change is an increase of the taxation on dividends in several circumstances.

In practice, by virtue of the French domestic rules (implementing the EU Parent company Directive), no withholding tax ("WHT") applies to parent company, i.e. dividends paid to a parent company holding more than 5% of the share capital of a taxable distributing entity for at least two years. In addition under the Former DTT, a maximum 5% WHT applied to distributions when the recipient was a company holding at least 25% of the share capital of the distributing company.

The New DTT states that no WHT will be due in France on dividend distributions made to a resident company holding at least 5% of the share capital of the distributing company for at least 365 days. When those conditions will not be met, the New DTT will limit to 15% the WHT rate.

The New DTT implements specific rules for dividends paid by real estate investment structures subject to annual distribution obligations and benefiting from a tax exemption regime (i.e. French SIIC, OPCIs, SPPICAV, etc.) which would qualify as UCIs. Dividends distributions deriving from real estate incomes will be subject to a WHT capped at a 15% rate if the beneficiary holds directly or indirectly less than 10% of the investment structure share capital. The domestic WHT rate will otherwise apply, i.e. at 30% in France (to be progressively reduced down to 25% in 2022).

In practice, OPCI structures fully held by Luxembourg holding companies that benefit from a 5% WHT rate will in the future suffer an increase of the French WHT up to 30%.

Moreover, under the Former DTT, dividends are only taxable in the country of source. By virtue of the New DTT, the dividends are taxable in the jurisdiction of the beneficiary entity. As such, Luxembourg will tax dividends received from a tax exempt subsidiary, the other distribution usually benefiting from the participation exemption.

Broader scope for capital gains on real estate companies (Article 13 of the New DTT)

The principle of a taxation of the capital gain on the disposal of shares in a real estate company in the country where the property is located remains unchanged.

The New DTT adds a condition to appreciate if the company qualifies as a real estate company. The criteria of more than 50% of the value deriving from real estate assets (other than properties operated for the business) is appreciated at any time during the 365 days preceding the disposal. In practice, the fact that the real estate component is appraised at any time during the 365 days preceding the disposal means that capital gains made upon disposal of shares in a company which sold all of its French real estate assets would remain subject to taxation in France for 365 days.

Entry into force

The New DTT has not yet entered into force and remains subject various steps of ratification. It will enter into force as from the first calendar year following the ratification both in France and Luxembourg, i.e. 1st January 2019 being the earliest application date if all the steps are met before year end.

With thanks to Solène Guyon of Ashurst for her contribution.