New protocol will end tax-free sales of French real estate for foreign investors using Luxembourg holding companies.

The fourth amendment to the France-Luxembourg tax treaty was signed on 5 September 2014. Although it was announced in 2012, this modification is rattling foreign real estate investors because they will have to revise their forecasts downward to take into account corporate income taxes at a rate of around 34.43 percent when they dispose of their investment. The scope of the amendment is limited to the question of real estate capital gains. Up to now the right to tax the capital gains made by a Luxembourg company from a sale of the units of a French "real estate predominant character company" (société à prépondérance immobilière) was attributed to Luxembourg, where application of the "participation exemption" regime provided that the capital gains were exempt subject to certain conditions. This right to tax capital gains will now be attributed to France.

Gains derived from the alienation of stocks, shares or other rights in a company, a trust or in any other institution or entity with a real estate predominant character shall only be taxed in the State where the immovable properties or rights are located. An entity is considered to have a real estate predominant character if (1) its assets derive directly or indirectly more than 50 percent of their value from real estate assets or rights, or (2) more than 50 percent of the entity's value derives from real estate assets or rights. Real estate used for the business of the entity will not be taken into account.

To our knowledge, this is the broadest possible definition because it contains several tests:  an objective ratio of the valuation of the assets of the company whose shares are sold, but also a more subjective calculation that takes into account the assets whose value is based on real estate assets. Must one use the value of the underlying real estate and compare it to the value of the other assets of the company whose other assets are sold?  In any event, this is one of the possible interpretations mentioned in the commentaries of the OECD Model Tax Convention, but this would lead to considering companies as real estate companies that are clearly not real estate companies since only the real estate assets used for the business of the companies whose shares are sold are excluded.  Must one include in real estate assets any bonds held against the real estate companies whose performance necessarily takes into account the performance of the real estate?  The tax authorities could once again be tempted to do this.  We eagerly await their commentary on these issues.

For tax withheld at source, the amendment will apply to income received in the calendar year following the year in which the Protocol enters into force. For other taxes, it will apply for tax years beginning after the calendar year following the year in which it enters into force. Therefore, this amendment could apply as early as 2015 and certain investors are probably planning to carry out early sales to be able to benefit from the last days of the old treaty. 

What about the future? Paying taxes on the disposal of the investment would not be such an issue for investors if the corporate income tax rate in France were not the highest in the European Union and if our tax rules were even slightly stable.  Let us just hope that foreign investors do not get discouraged and that alternatives offered to them will convince them to keep their investments in France.