On 5 September 2014, France and Luxembourg signed a fourth amendment to their Tax Treaty, resulting in significant changes for operators owning French real estate through Luxembourg entities.

Under Article 3 of the Treaty, France has the right to tax capital gains arising from the disposal of real estate assets, but the definition of real estate under the existing Treaty is limited as it only relates to buildings or specific partnership interests as defined under Article 1655 of the French Tax Code.

As a result, the capital gains derived from the sale of real estate property companies with a separate legal personality to that of the shareholders (e.g. SCI, SA, SARL) should not be treated as a real estate capital gain under the existing Treaty.  Such gain should only be taxed in the State of residence of the seller.

The fourth amendment introduces a new paragraph to Article 3 of the Treaty relating to the disposal of real estate property through one of several entities.  More precisely, it provides that “the capital gain arising from the disposal of shares or other rights in a company, a trust or any other institution or entity:

  • whose assets or property consist, for more than 50% of their value, of immovable property or;
  • derive more than 50% of their value directly or indirectly from immovable property or rights from immovable property, 

are taxed in the State in which the immovable property is situated”.

Immovable property used to conduct the company’s business is not taken into account for the purposes of this test.

As a result, the capital gains deriving from the sale of real estate property companies will now be treated as a real estate capital gain.

This will mean that such gain will be subject to withholding tax at a rate of 33.33%, which may be offset against French corporate income tax due from the seller.  Additional taxes may also be due, resulting in taxation of the capital gain at a rate of up to 38%.

The fourth amendment does not provide any grandfathering clause, meaning that this provision will be applicable to existing structures on the whole gain (and not merely to the relevant proportion of the gain realised after the entry into force of the protocol).

Once the ratification processes have been completed, the amended Treaty will enter into force on the first day of the month following the one during which the ratification process has been completed.  In addition, the amended Treaty provides that such modification will be applicable for gains realised in the calendar year (or fiscal year starting after the start of the calendar year) following the one during which the Treaty enters into force.

Our recommendation

For companies with a fiscal year ending on 31 December, the new tax treaty will be applicable for capital gains realised on or after 1 January 2015 if the ratification process is completed by 30 November 2014.  As a result, existing structures should be reviewed to take account of the new provision in the Treaty.