Treaty to make French taxes ‘more difficult to avoid’ for Luxembourg funds

Luxembourg-based funds doing business in France will find it more difficult to avoid French taxes once the new double-tax treaty between the two countries comes into effect early next year, according to one tax expert.

Under the new treaty, which was signed in March this year, it will be “more difficult for Luxembourg funds with agents in France to avoid creating a permanent establishment (taxable presence in France),” Benoît Rose, a partner at Luxembourg law firm CMS Luxembourg wrote in a note on the changes.

He said that a Luxembourg entity is now likely to be considered as having a permanent establishment in France “if an agent habitually negotiates contracts in France which are routinely concluded without material modification in Luxembourg.” Previously, funds successfully avoided creating a permanent establishment in France or another country “by ensuring that their representatives there did not have the authority to enter into contracts,” according to Rose.

The new treaty stems from the OECD’s base erosion and profit shifting initiative, which aims to stop funds and other entities from taking advantage of low-tax jurisdictions if they don’t have “substance” in those countries. It replaces the current treaty, which was set in 1958.

The new rules will “dis-apply treaty benefits if it is reasonable to conclude that obtaining treaty protection was one of the principal purposes of a transaction or arrangement,” Rose said. He cautioned that “fund managers should be alert to this risk where their funds are heavily reliant on treaty relief” and says that a manager will ”need to show it had substance in Luxembourg and had been set up there for commercial reasons” rather than to secure treaty benefits.

The new treaty will also increase withholding taxes on dividends paid by French real estate investment companies such as the SIIC (France’s equivalent to the REIT) or through another vehicle known as the OPCI. Investors in these vehicles will now have to pay 15 percent tax if they hold less than 10 percent of the vehicle, and rates of up to 30 percent if they hold 10 percent or more. This is a significant change compared to the previous 5 percent tax rate for holdings of up to 25 percent.

A further change attempts to stop investors in real estate funds from avoiding tax by disposing of some assets before the full asset sale. Previously, France taxed Luxembourg residents’ gains on a share sale when more than 50 percent of the value was derived from land in France at the time of disposal. But it will now apply the tax if the 50 percent threshold has been met or exceeded at any time during the 365 days preceding the sale.