Luxembourg and France signed, on 20 March 2018 a new double tax treaty replacing the current tax treaty of 1958 and including the new international tax standards. The text has been published and entry into force is now subject to completion of the ratification process by both countries.
The main new tax provisions that may affect Luxembourg taxpayers are summarized below.
Scope and residents
In the treaty, “residents” now refers to persons who are subject to tax, in line with the new OECD model.
When non-individuals are treated as residents by both Luxembourg and France, the treaty foresees that they will be considered resident in the State where they have their effective place of management.
Persons such as trustees or fiduciaries that are not the beneficial owner of the income cannot be treated as residents in the sense of the treaty.
The provisions on the definition of permanent establishment (PE) are now in line with the new OECD model, but goes beyond the choices made by Luxembourg in the context of the Multilateral Convention to implement tax treaty related measures. (MLI).
The most significant change concerns the insertion on commissionaire arrangements, which have been expanded to include situations in which the dependent agent “habitually plays the principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise.”
The provisions on independent agents have also been expanded: activities of independent agents may constitute a PE in cases where they act exclusively or almost exclusively on behalf of one or more enterprises to which they are closely related.
Furthermore, the treaty includes Option B of the MLI for the specific activity exemption. Thus, certain activities may be carried out in Luxembourg or in France without creating a PE in this country irrespective of whether the activity is of a preparatory or auxiliary character. The treaty now also includes an anti-fragmentation rule.
Dividends – withholding tax
The new text provides for an exemption from withholding tax on dividends, in cases where the recipient is a company and has held a minimum 5% interest in the capital of the company paying the dividends over a period of 365 days. The current tax convention only provides for the possibility to reduce the withholding tax to 5% when the recipient is a company that holds at least 25% of the capital of the paying company.
Undertakings for collective investment (UCIs) established in Luxembourg or in France (although they would not be treated as resident in the sense of the new treaty) may benefit from the treaty provisions on dividends and interests, to the extent that (i) this UCI can be assimilated as a UCI of the other contracting State, and (ii) the beneficiaries of the UCI are residents of one of the contracting States or of a State that has concluded an administrative assistance treaty to combat tax fraud and tax evasion with the source State.
Elimination of double taxation in Luxembourg
Dividends from shareholdings of at least 25% in French companies will no longer be tax-exempt in Luxembourg under the treaty, but will benefit from a tax credit. Therefore, dividends from shareholdings might only be exempt in Luxembourg in the future based on the Luxembourg domestic participation exemption regime provided that the conditions are met.
Real estate income and capital gains
The provisions on real estate income and gains do not significantly differ from the current ones and are basically in line with the OECD model. Real estate income remains in principle subject to tax in the source State. The definition of real estate assets has been formalized and refers to the law of the State where the asset is located.
Gains of a Luxembourg- or French-resident investor from the sale of real estate companies (that derive more than 50% of their value directly or indirectly from immovable property located in the other contracting State at any time during the 365 days preceding the sale) are taxable in the other contracting State. The 365-day period is a new element, which is in line with the MLI, although Luxembourg had not chosen this option.
A specific measure has also been added for individuals selling shares of a company that is resident in the other contracting State in which they (the individuals) hold a substantial participation (i.e. direct or indirect participation in 25% of the profits, alone or together with related persons)—the measure only applies if they have been resident in this other contracting State at some time in the previous 5 years.
Frontier workers – taxation of salaried income
Luxembourg will keep its full taxation rights on the salaried income in cases where a French-resident individual working for a Luxembourg employer exercises his/her functions in another State (France or a third State) for a period not exceeding 29 days in total per year. In addition, the treaty specifies that the right to tax statutory pensions (1st pillar) remains with the source State.
However, an important change is expected for French commuters. Contrary to the provisions of the double tax treaties with Belgium or Germany, French-resident individuals will not be exempt in France on their Luxembourg salaried income, but subject to tax there with a credit for the amount of Luxembourg tax suffered.
Anti-abuse rules and the PPT
The treaty now includes the general anti-abuse rule (the so-called “principal purpose test”), which allows Luxembourg or France to deny a treaty benefit to a taxpayer if obtaining that benefit was one of the principal purposes of the arrangement or transaction, unless it is established that granting that benefit was in accordance with the object and purpose of the relevant provisions of the treaty. This is consistent with the choice made by Luxembourg in the MLI.
Additionally, France will also expressly be able to apply its domestic anti-abuse rules, such as the domestic provisions on controlled foreign companies (CFC), despite any contrary provisions of the treaty.
Entry into force
The treaty will come into force on 1 January of the year following the ratification of the treaty by Luxembourg and France. If the ratification process is completed in 2018, the provisions would therefore apply as of 1 January 2019.