Luxembourg has been used for many years as a platform for French real estate investments notably due to the favourable provisions of the France/Luxembourg tax treaty leading to an exemption for the capital gains and real estate income deriving from French real estate assets realised by a Luxembourg entity.
France and Luxembourg signed a new tax treaty on 20 March 2018 which has significant implications for French real estate investments made by Luxembourg operators. The new treaty provides that it will be applicable on 1 January of the year following the ratification procedure by both States. Therefore, the new treaty will be applicable from 1 January 2019 at the earliest.
The treaty was first modified in 2006 in order to allow France to tax rental income and capital gains derived from French real estate property owned by a Luxembourg company. However, even after this modification, there was still room to implement a tax-efficient structure as France still did not have the right to tax capital gains realised by a Luxembourg company selling shares in a French real estate company.
The treaty was modified again in 2014 (with an application date of 1 January 2017) in order to end this loophole. France then recovered its rights to tax such capital gains.
Nonetheless, the treaty still offered some benefits where real estate assets are owned through a specific French regulated real estate vehicle such as SPPICAV. Indeed, SPPICAV are exempted from French corporate tax on rental income and capital gains subject to minimum distribution requirements to shareholders. Therefore, the key point was to minimise this withholding tax.
Most of the recent tax treaties signed by France provide that the withholding tax applicable on dividends distributed by SPPICAV is equal to the domestic withholding tax rate (30%). This was not the case for the France/Luxembourg tax treaty due to its specific wording. Indeed, dividends distributed by a SPPICAV to a Luxembourg entity owning more than 25% of such structure are only subject to a 5% withholding tax.
The new treaty implements a provision which allows France to apply its domestic withholding tax rate on dividends (currently 30%) distributed to a Luxembourg shareholder owning at least 10% of the real estate investment vehicle (eg SPPICAV).
In addition, dividends received by a Luxembourg vehicle from a French real estate regulated investment vehicle will no longer benefit from a corporation tax exemption in Luxembourg but rather will be subject to tax at the standard corporate rate albeit the French withholding tax may be offset against such corporate tax liability.
Because of the significant increase in the corporate tax liability resulting from Luxembourg entity/SPPICAV structures, operators may envisage undertaking some reorganisations prior to the entry into force of the new Treaty.
Rather than being held by a Luxembourg company, the SPPICAV might be held by a Luxembourg collective investment vehicle meeting certain criteria as the withholding tax will be limited to 15% in this case. Alternatively, it could be envisaged to increase the SPPICAV indebtedness (and accordingly the interest expense) in order to minimise its net income which has to be distributed. Other alternative acquisition structures may also be envisaged.
Operators should review and reconsider the holding structure of French real estate investment through Luxembourg entities. Any restructuring will have to be notably justified for economic and financial reasons (ie it must not be justified for mainly tax reasons) as the French tax authorities are very likely to scrutinise carefully restructurings made during such interim period. In addition, one should note that the new Treaty includes a general anti-abuse provision providing that a benefit under the new Treaty shall not be granted if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining this benefit was one of the principal purposes of a transaction or an arrangement.