Court rules that tax-exempt status means that treaty benefits are unavailable.

In two decisions of 9 November 2015, which have caused intense debate, the French Administrative Supreme Court attempted to put an end to inconsistency in case law regarding the interpretation of the criterion to qualify as a resident within the meaning of double-tax treaties. According to these decisions, a person qualifies as a resident in a jurisdiction if it is effectively taxed there, and not only liable to tax. The stakes are high, as the central question is whether a foreign taxpayer is entitled to the benefit of the double tax treaty with France.

The German provident fund LHV and the Spanish pension fund Santander, entities which are tax exempt in their respective jurisdictions, had invested in French securities. The dividends received from the French source were subject to a withholding tax at the 25 percent rate under the ordinary law in force at the time. The two companies claimed that the withholding tax should be reduced to 15 percent under the France-Germany and France-Spain Tax Treaties.

The French tax authorities refused to apply the reduced rates, on the grounds that the companies were not tax residents of Germany or Spain within the treaties' meanings since they were not effectively taxed in these two countries.

The issue was then whether a company must be effectively taxed in a State to be deemed a tax resident of such State within the meaning of the treaties, or if the mere fact of being within the tax's scope suffices.

The first step of the reasoning of the Court was that tax treaties must be interpreted in accordance with the ordinary meaning to be attributed to their provisions, within the context of the treaties and in light of their purpose, which is mainly to avoid double taxation. The Court then decided that persons who are tax exempt in a given State by reason of their legal status or their activity are not subject to such tax within the meaning of the treaty. Consequently, they cannot be considered as residents of such State for the application of the treaty, and must be therefore deprived of the benefit of the treaties.

The public rapporteur's argument in the Santander case was that the decisive criterion could not be the effective payment of the tax, as it would make the definition of a resident subject to fluctuation depending on the numerous factors that can affect its tax position (e.g. a loss-making fiscal year, income lower than the threshold for being subject to tax, applicable tax credits).

The Court had previously made a ruling on this issue in the Regazzacci case (French Administrative Supreme Court, Jul. 27, 2012, nos. 337656, and 337810), in which it had recognized that a British taxpayer subject to the remittance-basis tax regime was a tax resident, for the purpose of the double tax treaty with France, i.e., the taxpayer was exempted from taxes on its foreign income until such time as it was repatriated to the United Kingdom. The Supreme Court had based its decision on the method of comparing the language versions of the treaty, noting that the English version of the treaty referred to persons "liable to tax", i.e., persons within the tax's scope, and not to persons "subject to tax", i.e., effectively subject to paying the tax.

The French Administrative Supreme Court's ruling is somewhat unsettling in certain respects (e.g. no reference to foreign version of the treaty, interpretation of the term "resident", which could have differed given the tax treaty's wording). Lastly, we note that a large number of treaties (e.g., with Middle Eastern countries and Luxembourg) do not require that a person be subject to a tax in order to establish that it is a tax resident. In some of these countries, residents may be completely exempt from taxes and still invoke treaty provisions.