The DTT adopts the new OECD standard definition of the tax residency according to which a «resident of a contracting State» refers to a person who is subject to tax in such state by reason of having among others its domicile, residence or place of management, in such state.
Unlike the current treaty, in which an entity is considered a resident of a treaty country based on its place of effective management, the provisions / benefits of the DTT do not apply to persons (including legal entities) which are, despite being effectively managed from a treaty country, not subject to tax in their country of establishment.
A protocol attached to the DTT, forming an integral part of the DTT, contains specific provisions allowing undertakings for collective investments (“UCI”) to benefit from the DTT provisions regarding dividends and interest under certain conditions, provided that such UCI is assimilated by the other treaty country to the UCIs existing under the internal laws of that treaty country.
Withholding tax on dividends
The DTT adopts a broader definition of the notion of dividend which includes all income treated similarly as a dividend under the tax law in the source state. Examples include deemed distributions (due to e.g. advantages granted to a related party without economic counterpart) which are exempt from dividend withholding tax under the current treaty.
It also provides for a reduction of the 15 per cent withholding tax treaty rate on dividends to 0% (currently 5%) when the distribution is made by a company which is a resident of a tax treaty country to a beneficial owner which is a company that holds directly a participation of at least 5% (currently 25%) in the distributing company. However, in order to prevent abuse, the exemption of dividend withholding tax is subject to the condition that the shareholder had owned the minimum participation for an uninterrupted period of at least 365 days. This condition is in line with the relevant provisions included in the MLI.
Specific provisions apply to dividends distributed by real estate investment funds (e.g. French OPCIs) which can – under the wording of the current treaty – benefit from a reduced withholding tax rate (5%) provided certain conditions are met. Based on the DTT such distributions will become subject to the domestic withholding tax rate (30% in France / 15% in Luxembourg) unless the dividend is distributed to a resident of the other treaty country which is the beneficial owner of such dividend(s) and which holds directly or indirectly less than 10 % of the share capital of the real estate investment fund distributing the dividend, in which case the withholding tax cannot exceed 15%.
Elimination of double taxation
France applies the tax credit method to avoid double taxation while Luxembourg only uses this method for dividends, royalties or director’s fees and relies on the exemption method for any other item of income derived by a resident of Luxembourg and arising from France.
Under the DTT, Luxembourg shall no longer grant a full tax exemption in respect of dividends received by a company which is a tax resident of Luxembourg and received from a company which is a tax resident of France whilst the Luxembourg company has a substantial participation (25%) in the French company. Such dividends should however continue to be fully or partly exempt from Luxembourg income tax when the conditions of the Luxembourg participation exemption or half exemption regime are met. However, as a direct consequence of the change, dividends distributed by e.g. French real estate funds (e.g. OPCIs) can no longer benefit from the income exemption provided for in the current treaty and shall equally not qualify for the application of the Luxembourg participation exemption since such fund would not meet the subject to tax condition imposed under the Luxembourg participation exemption rules.
The DTT includes the so-called “principal purpose test”, introduced by the MLI, which provides that a benefit under the treaty shall not 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 granting that benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the treaty.
Entry into force
In a nutshell, the DTT shall enter into force as from the first January following the completion of the ratification process by both countries, i.e. as from 1st January 2019 at the soonest.
* * *
The elements presented above constitute only a brief summary of the most relevant changes resulting from the DTT. The impact of these provisions on the existing investment structures as well as on those that could be put in place in the future should be analyzed on a case-by-case basis.
Tiberghien Luxembourg remains committed to the progress of the enforcement of the DTT. If you would like to receive more information, then please contact your trusted adviser at Tiberghien Luxembourg or contact any of the authors of this publication.