The doubt tax treaty (DTT) between France and Luxembourg contains a favorable tax regime for capital gains on shares of real estate companies. Real estate investment in France with use of holdings in Luxembourg leads to a double non-taxation under certain circumstances.
Under the current legislation, and until the new amendment comes into force, a company that is a tax resident of Luxembourg benefits from an exemption of capital gains tax in France under certain conditions. It has to be fully taxable in Luxembourg or have a permanent establishment there. The exemption takes the form of a double non-taxation for shareholders of a French SCI or a participation-exemption for shareholders of a French SAS.
The additional clause to the tax agreement between France and Luxembourg introduces major changes. The transactions that meet the following conditions fall into the scope of the new paragraph 4 of the Article 3:
- Amounts at issue: on disposal of company's shares, of a trust or any other legal entity or institution;
- Assets or goods consist of or derive their value from real estate in France for more than 50% (of total worldwide assets);
- The real estate goods at issue are owned directly or indirectly (through trusts, institutions, legal entities); and
- Real estate property or property interests located in the Contracting States.
The main change introduced by the additional clause to the DTT is that the State is entitled to tax where the property is located, which in this case is France. Therefore, capital gains on the disposal or sale of securities will be taxed in the State where the real estate property is located i.e. at a French corporation tax between 33.33% and 38%.
However, these gains are exonerated if the property was allocated to the company's business (e.g. hotel, care home, student housing etc.). The scope of this agreement contains two specificities, which are as follows:
- The substantial scope includes a specificity concerning the calculation of the capital gain.
The capital gain is calculated on the basis of 100% of unreleased gains. Therefore, the starting point of the detention period for the calculation of the gain is the day of its acquisition (i.e. before the amendment was brought into force). As a consequence, old French portfolios owned by a French company which is held through a Luxembourg company should trigger the existing latent capital gains in order to avoid being taxed in the future upon the past gains.
- The temporal applicability of the additional clause contains conditions regarding the entry in force and the applicability of the additional agreement.
The new version of the convention comes into force not earlier than the first day of the month following the notification of ratification of the convention by each State.
After this phase there is a postponed application condition. The convention takes effect on the 1 January of Y+1, following the year of the entry in force of the additional agreement.
Currently, no request for the ratification bill has been submitted to the French Parliament, and the Luxembourg foreign authorities have announced that their ratification process will be implemented at the beginning of 2015 at the soonest. Thus, the entry in force is expected not earlier than 2016.
Example: If the last ratification notice is received in 2015 the convention comes into force on the 1 January 2016, consequently taking effect only in 2017.
Indeed, these specificities show that investors in French real estate have still enough time to think about potential solutions.
Firstly, the contribution of real estate shares to a French regulated real estate vehicle (OPCI) might allow the benefit of an exoneration on the whole latent capital gains as well as on real estate transfer taxes (under certain circumstances). However this option would favour portfolios which are worth more than €50 million due to the amortisation of the additional management costs relating to a regulated vehicle.
Another option would be to liquidate the holding company in Luxembourg, in order to transfer the shares of the French real estate company to shareholders located in other countries. In this case the DTT governing the future taxation would not be the DTT concluded between France and Luxembourg, but the DTT between France and the shareholder's State.
As many of the DTTs do not include similar mechanisms, other solutions are manageable individually depending on the DTT between France and shareholder's State, the substance requirements and the investment policy of the shareholders.
Continued vigilance is needed as to the risk of committing an abuse of law regarding Article 64 of the LPF (French Tax Procedure Handbook).
If the French tax authority concludes that overall the exclusive goal of the operation is tax evasion, the shareholders will be fully taxed on capital gains with an additional 80% tax increase due to abuse of rights. In order to avoid such situations, the transaction advisers must ideally attempt to have a non-tax incentive or other than one provided by French rules.