On September 5, 2014, French Minister of Finance Michel Sapin and Luxembourgian Minister of Finance Pierre Gramegna signed an amendment to the France–Luxembourg Tax Treaty (1958) (the "Tax Treaty"), as amended by the 1970 exchange of letters and by the 1970, 2006, and 2009 protocols.
The amendment, in line with the current OECD Model Tax Convention on Income and Capital, reverts to the tax treatment of capital gains arising on the direct and indirect disposal of real estate assets and puts an end to the potential double-tax exemption regularly applied until now regarding sale of real estate companies' shares.
Former Tax Treatment. The former tax treaty permitted the avoidance of taxation on capital gains arising from the disposal of real estate assets located in a related country held through one or several interposed entities in the other country. Indeed, such sale did not qualify as real estate income with respect to the Tax Treaty and was therefore not taxable, neither in France nor in Luxembourg.
For instance, where a Luxco sold the equity interest held in a French real estate entity, no taxation was applied since the capital gain arising on this sale was:
- Tax exempt in Luxembourg, as the Luxembourg tax authorities treated the sale as a sale of French real estate that was taxable in France only pursuant to the former Article 3 of the Tax Treaty; and
- Also tax exempt in France, as the Tax Treaty did not provide that an equity interest in a real estate partnership must be viewed as a real estate investment, so the gains were not taxable in France unless the selling Luxco had a permanent establishment in France.
Tax Treatment Resulting from the Amendment.The amendment modifies this tax treatment and puts an end to the above potential double-tax exemption. Indeed, the amendment provides a new paragraph to Article 3 of the Tax Treaty (i.e., a "Prépondérance immobilière" clause) specifying the case of the sale of shares of a company, fiduciary, or any other institution or entity whose assets consist for more than 50 percent of their value—directly or indirectly through one or several companies, fiduciaries, institutions, or other entities—of real estate assets.
Under this new rule, capital gains arising on the sale of shares of such entities would be taxable only in the country in which the related real estate assets are located.
The amendment will enter into force on the first day of the month following the reciprocal notification of its ratification in both states.
Pursuant to Article 2.2 of the amendment, the new rule will apply:
- To capital gains taxable after the calendar year during which it enters into force, for income taxes levied as a withholding tax;
- To capital gains occurring during tax years beginning after the calendar year during which it enters into force, for income taxes not levied as a withholding tax; and
- To taxation whose action rendering the taxes assessable occurs after the calendar year during which it enters into force, for other income taxes.
Accordingly, where the amendment would be ratified by both states before December 31, 2014, only capital gains realized as from January 1, 2015, should fall under the scope of this new rule.