Does the application of a withholding tax in France on dividends paid by French companies to Luxembourg SICARs constitute a discriminatory measure as regards European Community law?

According to French domestic law, dividend distributions paid by French companies to Luxembourg investment companies in risk capital (SICARs) are subject to the 25% withholding tax set forth under article 119 bis of the FTC, with no possibility to benefit from the exemption set forth under article 119 ter of the FTC (indeed, the application of the favourable provisions of this article requires that the legal entity located in the other European Community (EC) member state and receiving the dividends be subject to corporate income tax in that state without being tax-exempted, which is not the case of SICARs since these are taxexempted in Luxembourg on passive income received).  

From a tax perspective, dividend distributions made by French companies to Luxembourg SICARs are thus treated in a less favourable manner compared with dividend distributions made to comparable French vehicles such as French investment companies with variable capital (SICAV) or mutual funds (FCP), since these distributions are tax-exempted.

In this respect, and more generally, the European Commission has announced, in a communication dated March 18, 2010 (IP/10/300), that it has officially asked the French government to modify the rules regarding the treatment of dividends paid to investment funds located in other European Union (EU) and European Economic Area (EEA) member states, since these rules constitute obstacles to the free movement of capital set forth in the treaty on the functioning of the EU and the EEA.

In this context, with respect to the specific situation of dividends distributed to SICARs, the only way for France not to be considered as being in breach of the EC law would be to demonstrate that compliance with EC law is guaranteed by the double tax treaty between France and Luxembourg dated April 1st, 1958 (application of EC case law: ECJ December 14, 2006, case 170/05 Denkavit; ECJ November 8, 2007, case 379/05 Amurta), which implies, beforehand, that SICARs could benefit from this treaty (i.e., that they can qualify as “resident” within the meaning of the treaty).

In this respect, the French government considers that SICARs cannot benefit from the reduced withholding tax rates on passive income laid down in the double tax treaty, since SICARs cannot establish that the income they generate is actually subject to corporate income tax in Luxembourg (Rép. Dassault: AN July 4, 2006, n°92093). This position is in line with the approach by the French tax authorities regarding the French- Algerian double tax treaty, according to which a person exempted from tax in a country is not considered as being subject to tax in that country and cannot therefore qualify as a resident which may benefit from double tax treaties (administrative guidelines May 22, 2003, 14 B-3-03 n°5).  

This position can however be questioned in several respects:  

  • Firstly, comments relating to article 4 of the OECD model tax treaty regarding the definition of “resident” do not seem to adopt such a strict interpretation of this concept, notably acknowledging that, according to domestic laws of various countries, a person is considered as being subject to tax even if the country does not de facto apply tax to this person, most of these countries moreover considering these persons as residents for the purposes of double tax treaties (see comments dated July 22, 2010 regarding the OECD tax treaty model, §8.6 et §8.7).
  • Secondly, with respect to the double tax treaty between France and Germany which contains a definition of the concept of tax residency which is in line with the OECD tax treaty model, a judgment rendered by the Montreuil tribunal on January 14, 2010 indicate that the quality of resident is not subject to a condition of effective payment of tax in the state of residency.  
  • Thirdly, the definition of tax residency laid down in the double tax treaty between France and Luxembourg is different from the definition laid down in the OECD tax treaty model, since it is not necessary to be subject to tax so as to be considered as a “resident” (only article 8-3 indicates that in order to benefit from the “avoir fiscal” – tax credit on dividends – transfer, the beneficiary of the “avoir fiscal” transfer should also justify that he is taxed in Luxembourg on these dividends).

Thus, serious arguments exist in our view to conclude that, contrary to the position of the French tax authorities, SICARs should be qualified as “resident” within the meaning the double tax treaty between France and Luxembourg, and, consequently, benefit from the provisions of that double tax treaty.

The application of the French-Luxembourg double tax treaty provisions relating to dividends (even if it was admitted) should however not allow the circumvention of all discrimination as compared to the regime applicable to distributions paid to French investment funds. Indeed, the double tax treaty only sets forth a reduced withholding tax rate on dividends (vs. withholding tax exemption) which could not in be practice “neutralized” by the tax credit mechanism since this tax credit could only be used on the tax due in Luxembourg in respect of these dividends by the entity receiving dividends (dividends received by a SICAR are tax-exempted in Luxembourg).

Based on the above, the application in any case (i.e., with or without application of the French-Luxembourg double tax treaty) of a withholding tax on dividends paid by French companies to SICARs seems to constitute a discriminatory measure according to EC law to which the French authorities, without a doubt, will have no choice but to put an end to in due course. Meanwhile, the question remains as to whether the French distributing companies must continue to withhold taxes upon distribution, as well as the question of a potential claim for repayment of withholding taxes “wrongfully” paid in the past.