The present French Tax Update will focus on (i) the most salient features of the new double tax treaty signed by the People's Republic of China (China) and France on November 26, 2013 (New DTT), (ii) the new double tax treaty signed by Singapore and France on January 15, 2015, (iii) certain noteworthy court decisions issued in the last months of 2014, and (iv) the publication of an administrative list of fraudulent and abusive transactions.
NEW DOUBLE TAX TREATY ENTERED INTO BETWEEN CHINA AND FRANCE
The New DTT was to become effective as from January 1 of the year following that in which the ratification procedures in each France and China had been completed. The reciprocal notification was carried out by both countries on November 28, 2014, so that the New DTT has entered into force as from January 1, 2015. The New DTT replaces the former treaty signed on May 30, 1984 (Old DTT).
TAX RESIDENCE CRITERIA
For taxpayers other than individuals, (i) the criteria of the location of the head office has been replaced by the criteria of the place of incorporation and place of effective management, and (ii) the place of effective management should be the criteria to resolve tax residency disputes under the New DTT.
For individuals, the New DTT now provides specific criteria to determine the tax residency of an individual who is a resident of both China and France under Chinese and French domestic laws: permanent home, center of vital interest, habitual abode, and nationality.
ELIGIBILITY OF PARTNERSHIP TO TREATY BENEFITS
The New DTT provides detailed rules regarding the eligibility of partnerships and other similar flow-through entities to treaty benefits. It should be noted that the extension of the residency Article to French partnerships recognizes their eligibility to treaty benefits by virtue of their specific domestic treatment (whereby partnership are not actually regarded as flow-through entities, but merely as translucent entities). Although such position is in line with the position usually taken by French tax authorities (FTA), it contrasts with their position regarding non-French partnerships, which are usually not regarded as tax residents as a result of their flow-through tax regime. In their official guidelines, the FTA nevertheless recognize the eligibility of non-French partnerships to treaty benefits, under certain conditions, for certain passive income items.
Using an identical wording to that included in the double tax treaty signed by France and the United Kingdom in 2008, Article 4 of the New DTT deals with six specific situations involving flow-through entities depending on (i) the income source, (ii) the location of the flow-through entity, and (iii) the recognition of the entity for tax purposes on a domestic level:
- In the situation where the partnership and its partners are tax residents of the same country while the relevant income has its source elsewhere:
- Article 4-4-a of the New DTT provides that, if (i) the country of establishment of the partnership qualifies partnerships as transparent entities and (ii) income derived from the country of source through the partnership is considered as its partners' income, such income should be eligible to the treaty benefits to the extent that such partners (a) are tax residents of the country of establishment of the partnership and (b) meet any other conditions required under the New DTT, regardless of whether tax transparency is recognized by the country of source;
- Article 4-4-b of the New DTT provides that if (i) the country of establishment of the partnership qualifies partnerships as tax-resident entities in respect of income received by its partners through the partnership and (ii) the partnership meets any other conditions required under the New DTT, the income derived from the country of source through the partnership is eligible for the treaty benefits, regardless of whether partnerships are treated as tax-transparent entities by the country of source.
- In the situation where the partnership is established in the country where the relevant income has its source:
- Article 4-4-c of the New DTT provides that if the country of source qualifies partnerships as tax-resident entities while the country of residence of the partners treats the partnership as a tax-transparent entity, the income derived from the country of source through the partnership may be taxed in the country of source;
- Article 4-4-d of the New DTT provides that if income derived from the country of source through a partnership established in the same country while the country of residence of the partners qualifies the partnership as taxable entities, that income is not eligible for treaty benefits.
- In the situation where the partnership is established in a third country:
- Article 4-4-e of the New DTT provides that if (i) such third country and the country of residence of the partners both qualify partnerships as tax-transparent entities and (ii) income derived from the partnership is considered as the income of the partners, this income derived from the country of source through the partnership is eligible to treaty benefits to the extent that such partners (a) are tax residents in the other country and (b) meet any other conditions required under the New DTT, regardless of whether tax transparency is recognized by the country of source, and subject to the existence of a mutual assistance clause between the third country and the country of source;
- Article 4-4-f of the New DTT provides that if income derived from the country of source through a partnership established in a third country while the country of residence of the partners qualifies partnerships as taxable entities, that income is not eligible for treaty benefits.
PERMANENT ESTABLISHMENT DEFINITION
Article 5 of the New DTT provides for an extension from six months to 12 months of the threshold for a building site, construction, assembly or installation project, or supervisory activities to constitute a permanent establishment.
Article 5 of the New DTT also modifies the threshold for the provision of services (including consultancy services) by a company to constitute a permanent establishment to more than 183 days within any 12-month period (instead of six months within any 12-month period). According to a Chinese tax circular interpreting the six-month threshold in the old article in China and Hong Kong tax arrangements (which technically would apply under the Old DTT), where an enterprise of France provides services for a particular project in China, the number of months between the month that an employee of the French enterprise first arrives in China to provide services on the project and the month that an employee finishes the project and leaves China would be regarded as the number of months for the purpose of the six-month calculation. If there is a consecutive period of 30 days where no employee of the French enterprise is in China for the project, one month may be deducted from the total. This modification should thus make it less easy for a French company to have a permanent establishment in China.
In accordance with the latest OECD commentaries adopting the so-called functionally separate entity approach, the New DTT adjusts its permanent establishment income determination policy by allowing the deduction of expenses incurred for the purposes of the permanent establishment, including executive and general administrative expenses (notably royalties, fees, or interest paid to the head office).
While dividend withholding tax charged by the source country shall not in principle exceed 10%, the New DTT introduces a reduced withholding tax rate of 5% if the beneficial owner is a company (other than a partnership) that directly holds more than 25% of the capital of the dividend-paying company (Article 10 of the New DTT).
It should be noted that paragraph 4 of the New DTT protocol extends the notion of dividends, with regard to a French dividend-paying company, to income treated as a deemed distribution by France (e.g., interest disallowed as a result of French thin capitalization rules).
The New DTT furthermore denies the application of the treaty benefits provided by Article 10 of the New DTT in cases in which the constitution or transfer of the relevant shares or rights was mainly motivated by such benefits.
Real estate-based dividends
In accordance with other double tax treaties recently signed by France, Article 10-6 of the New DTT denies the reduced withholding tax rates to dividends paid out of income or gains derived from real estate properties by real estate investment vehicles (e.g., SIICs and OPCIs for France).
Article 10-6 of the New DTT thus provides that domestic taxation (e.g., 30% withholding tax in France) may apply where the relevant nonresident investor holds more than 10% of a real estate investment vehicle (whereas a nonresident investor holding less than 10% of a real estate investment vehicle would be eligible for the reduced 10% withholding tax).
As under the Old DTT, Article 11 of the New DTT provides that withholding taxes on interest payments may not exceed 10%.
The New DTT furthermore denies the application of the treaty benefits provided by Article 11 of the New DTT in cases in which the constitution or transfer of the relevant instruments was mainly motivated by such benefits.
As under the Old DTT, Article 12 of the New DTT provides that withholding taxes on interest payments may not exceed 10% (reduced to 6% for rentals of equipment).
The New DTT furthermore denies the application of the treaty benefits provided by Article 12 of the New DTT in cases in which the constitution or transfer of the relevant rights was mainly motivated by such benefits.
Pursuant to Article 13 of the New DTT, capital gains realized on the sale of shares are no longer taxable in the country from which those gains are derived but only in the country in which the seller is a resident.
The country in which the seller is a resident, however, loses its taxing rights in the context of the sale of a substantial stake. The New DTT indeed provides that gains derived from the alienation of shares of a company are taxable in the country where the company is located if the seller, at any time during the 12-month period preceding such alienation, held a stake, directly or indirectly, of at least 25% in the share capital of that company.
In addition, Article 13 clarifies the circumstances under which a company, trust, or any other institution or entity is deemed to be land-rich for the purposes of the New DTT by providing that it is necessary that more than 50% of the assets directly or indirectly owned are immovable properties at any time within 36 months prior to the share transfer. As it was already specified in the Old DTT, capital gains realized on the sale of shares into land-rich entities are taxable in the country in which the relevant immovable property is located.
OTHER INCOME PROVISION
Whereas under the Old DTT the country of source generally had the taxing rights over so-called other income items, the New DTT changes such approach by providing that other income shall be taxed only in the country of residence (except where realized through a permanent establishment or a fixed place of business located in the country of source).
SPECIFIC ANTI-ABUSE PROVISION
The New DTT inserts a broad general anti-abuse rule under Article 24 that prevents the application of treaty benefits where it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining such benefits was one of the main purposes of the transaction/arrangement that resulted directly or indirectly in such benefits.
It should, moreover, be noted that such specific provision comes in addition to the limitation of benefits provisions that have been added to the passive income provisions (see above: in order to prevent treaty-shopping and in accordance with the recent OECD discussions on the use of treaty benefits in inappropriate circumstances, the New DTT has added limitation of benefits provisions to each of the passive income articles (Article 10 of the New DTT regarding dividends, Article 11 of the New DTT regarding interest and Article 12 of the New DTT regarding royalties, and Article 22 of the New DTT for other income)).
METHODS OF ELIMINATING DOUBLE TAXATION
On the Chinese side, the shareholding ratio requirement is increased under the New DTT from 10% to 20% in respect of dividend withholding tax credit. Such 20% rate is consistent with the change of Chinese domestic law effective as from January 1, 2008.
On the French side, it should be noted that the tax-sparing provision has been removed under the New DTT. The Old DTT indeed had a provision that provided that the amount of Chinese tax levied shall be deemed to be equal to 10% or 20% for dividends, 10% for interest, and 20% for royalties, notwithstanding the fact that the Chinese withholding tax actually paid is lower. The New DTT removes this tax-sparing benefit and allows French tax residents only to claim foreign tax credit on the amount of Chinese withholding tax actually paid.
It should, however, be noted that the tax-sparing benefit for royalties has been extended for 24 months pursuant to the Protocol to the New DTT.
NEW SINGAPORE-FRANCE DOUBLE TAX TREATY
On January 15, 2015, France and Singapore signed a new double tax treaty that will come into force upon completion of the constitutional requirements in the two countries.
Some of the significant features of the new treaty are as follows:
- The withholding tax on dividends is capped at 5% if the recipient has a participation of 10% or more of the share capital of the distributing entity; otherwise the withholding tax is capped at 15%.<
- There are specific anti-abuse rules in respect of distributions by REITs when the recipient owns 10% or more of the capital of the distributing REIT.
- With certain exceptions, where a full exemption is available, the withholding source on interest is capped at 10%.
- A specific anti-abuse rule applies when French-source income benefits from an exemption or a reduced rate of taxation and the relevant Singaporean recipient is taxed on a remittance basis; in such a case, the exemption or the reduced rate of taxation would apply only to the extent the relevant income is remitted to Singapore.
- A general anti-abuse rule applies when the main purpose of a given transaction is to obtain a favorable tax treatment under the treaty and such treatment is contrary to the purpose of the treaty in the case of such a transaction.
2014 YEAR-END NOTEWORTHY TAX COURTS DECISIONS
FRENCH WHT ON DEEMED DIVIDENDS
Under the relevant French tax rules, when certain expenses are nondeductible for corporate tax purposes, they may be deemed to be distribution of dividends in favor of the actual beneficiaries of such expenses. If such beneficiaries are nonresidents of France, the relevant items may be liable to French withholding tax (WHT).
In a decision dated June 23, 2014, the Conseil d'Etat effectively decided that the WHT would not violate the EU principles of freedom of establishment and freedom of provision of services (articles 49 and 56 of the TFEU).
The underlying situation was that a French parent company had provided to non-French affiliates certain benefits (e.g., not reinvoicing certain expenses borne on behalf of the affiliates, purchasing goods from the affiliates at above market rates, and so on), which had been considered as nondeductible and liable to WHT.
The WHT was challenged on the basis that the relevant affiliates were subject to a double taxation: the WHT and the corporate tax suffered in their home jurisdictions in respect of the same items, whereas the French affiliates would not have suffered a double taxation, hence the violation of the above EU principles.
The lower administrative court decided in favor of the administration (except when, under the relevant tax treaties, France did not have the right to apply the WHT to deemed distribution of dividends). The Versailles Court of Appeal confirmed the position of the lower court under the following reasoning: (i) the French affiliates would have suffered taxation given that the relevant items (e.g., the above-market sale price) would have been effectively part of their profits liable to French corporate tax; (ii) accordingly, the difference of treatment between French and non-French affiliates (WHT and French corporate tax) reflects only different ways of tax collection induced by their underlying different situations; and (iii) the fact that the same items are also taxable in the home jurisdictions of the affiliates does not imply that the WHT violates the above EU principles.
By confirming the decision of the Appeal Court, the Conseil d'Etat follows its own decision of May 9, 2012 (Sté GBL Energy) where it held that the disadvantages resulting from two EU countries exercising in parallel their respective taxing authorities do not violate the EU principles to the extent such exercise of taxing powers is not discriminatory vis-à-vis nonresidents.
WHT ON DIVIDENDS PAID TO NON-FRENCH NONPROFIT ORGANIZATIONS
In 2009, the Conseil d'Etat held that the WHT levied on dividends paid to certain foreign nonprofit organizations (NPOs) constituted a restriction on the EU law free movement of capital principle, given that French NPOs were exempt in respect of French-source dividends. Following this decision, the FTA issued guidelines allowing foreign NPOs to file a claim for recovery of WHT paid in respect of French-source dividends, to the extent the foreign NPO could demonstrate its comparability to French NPOs. To the best of our knowledge, the refund process has not been initiated by the FTA, which are waiting for the Conseil d'Etat to rule on the specifics of this comparability.
In this regard, on December 30, 2014, the Conseil d'Etat issued its first decision on one of the several cases pending before it, regarding VZB, a Berlin-based pension fund (VZB Decision).
In the VZB Decision, the Conseil d'Etat took the view that the analysis of the "nonprofit" character of the foreign NPOs in order to establish comparability with French NPOs (Nonprofit Test) should be based on the two main criteria of distinction used under French domestic law, i.e., (i) if the NPOs management is driven by profit-making objectives and (ii) if the services that the NPOs provide compete with commercial businesses.
As such, the Conseil d'Etat ruled that the Versailles Court of Appeal, which had granted VZB, in a July 3, 2012 decision, a total WHT refund, did not perform an accurate Nonprofit Test (especially in regard of the management of the fund) and asked the court to reexamine the case.
As presented in the June 2014 French Tax Update, the Versailles Court of Appeal had recently ruled in a March 4, 2014 decision regarding a UK pension fund, that only "pertinent criteria of distinction" should be relevant for the purposes of the Nonprofit Test, disregarding as such the arguments of the FTA inspired by the French domestic law requirements and based on the amount of the managers' compensation.
Upcoming developments by the Conseil d'Etat and the Versailles Court of Appeal will therefore be interesting to follow.
TRANSACTIONS WITH ENTITIES LOCATED IN NONCOOPERATIVE JURISDICTIONS
In a long-awaited decision dated January 20, 2015, the French Constitutional Court (Conseil constitutionnel) ruled on the conformity to the French constitution of the provisions of the French tax code (FTC) that essentially deny the applicability of the participation-exemption regimes for dividends and capital gains (Denial of Exemption Regimes) to dividends and capital gains derived from companies located in so-called noncooperative jurisdictions within the meaning of the FTC (NCJs).
The Denial of Exemption Regimes were challenged on the basis that, contrary to most of the provisions applicable to NCJs, which contain specific safe harbor rules allowing taxpayers to escape the applicability of such provisions by proving that the relevant arrangements were not driven by tax fraud or evasion, the Denial of Exemption Regimes did not provide for a safe harbor rule, disregarding as such the equality of treatment principle set forth in the French Constitution.
The Conseil Constitutionnel took the view the that Denial of Exemption Regimes could be compliant with the French Constitution only to the extent taxpayers are allowed to demonstrate that their investments within NCJs do not target the avoidance of French tax legislation but arebona fide transactions.
It is possible that this decision foreshadows the challenge of other anti-abuse provisions found in the FTC that do not provide for a safe harbor rule.
ADMINISTRATIVE SUPREME COURT TAKES INTO ACCOUNT FOREIGN LANGUAGE VERSION OF DOUBLE TAX TREATY
A French bank (Bank) held German law Genussscheine securities (Genussscheine) issued by a German entity and received payments under the Genussscheine in accordance with their terms and conditions, which inter alia provided that (i) the Genussscheine would give rise to a yearly payment of 6.6% of their nominal value, except where (a) the profits of the issuer would not be sufficient to make such a payment or (b) the share capital of the issuer has been reduced in order to offset losses and has not been brought back to its nominal value, and (ii) the payments made under the Genussscheine were deductible from the taxable result of the issuer.
The Bank credited the withholding tax imposed in Germany on the payments made under the Genussscheine in order to reduce its French corporation tax liability, in accordance with Articles 9 and 20 of the double tax treaty entered into between France and Germany (Fra-Ger Treaty). The FTA challenged the corresponding tax credit, arguing that the Genussscheine should be regarded as debt instruments (on the basis, inter alia, of their terms and conditions), and could thus not benefit from Articles 9-6 and 20 of the Fra-Ger Treaty.
In a recent decision (CE, October 10, 2014, n°356878), the Conseil d'Etat confirmed a principle already applied in a previous case involving the double tax treaty entered into between France and the UK (CE, July 27, 2012, n°337656-337810): both the French and the foreign-language versions of a double tax treaty are binding and may be used for interpretation purposes.
As Article 9-6 of the German version of the Fra-Ger Treaty expressly includes payments made under a Genussscheine in the definition of dividends (whereas the French version of the Fra-Ger Treaty translatesGenussscheine as droits de jouissance), the Bank was eligible to claim the tax credit corresponding to the withholding tax imposed in Germany on the payments made under the Genussscheine.
ADMINISTRATIVE LIST OF FRAUDULENT AND ABUSIVE TRANSACTIONS
The FTA have recently issued a list of several transactions that they view as abusive. Where challenged by the FTA, such abusive transactions may give rise to several tax penalties, including inter alia interest for late payment (at the monthly rate of 0.4%), specific penalties ranging from 40% to 100% (of the taxes being reassessed). In addition, transactions that also qualify as tax fraud may give rise to criminal penalties, includinginter alia fines and imprisonment.
The transactions listed so far include:
- Using a software hidden features to conceal income;
- Obtaining undue VAT reimbursements;
- Unduly withholding VAT amounts;
- Unduly claiming the VAT regime applicable to the margin realized by a broker of secondhand goods;
- VAT fraudulent schemes such as carousels;
- Fictitious/fake invoices;
- Artificial relocation of businesses operated in France;
- Savage ESOPs for the benefits of managers;
- Artificial relocation of the tax residency/domicile of an individual;
- Abusive use of certain tax incentives attached to French overseas territories;
- Concealing assets held abroad.
It should be noted that the list could be completed at any time and that it does not amount to officially published guidelines.
Within the list, the FTA make reference to so-called "savage" ESOPs for the benefits of managers, i.e., ESOPs that are set up by market participants outside the typical provisions of the French tax code (stock options or allocation of free shares as defined by the code). The FTA define these ESOPs as being structured around preferential arrangements in favor of the relevant managers (e.g., subscription by managers of securities indexed to the performance of the company), in transactions where any effective profit is realized in the form of capital gains that have a favorable tax and social security treatment (compared to employment income). The FTA take the position that such arrangements may be challenged under the abuse of law procedure and may be liable, inter alia, to a penalty of up to 80%.
The FTA also make reference to the artificial relocation outside of France of either (i) the head office of business entities that are formally registered in another jurisdiction (e.g., simple domiciliation address), albeit their business is actually still operated in France, or of (ii) an individual's residency/domicile for tax purposes, in order for him to avoid any or part of his French tax liabilities. The FTA take the position that such arrangements may be challenged under regular reassessment procedures but can also trigger, in the relevant cases, initiation of criminal proceedings.