France, Luxembourg amend tax treaty, affecting investment structures of Luxembourg vehicles holding French real estate

The French and Luxembourg governments have signed a new amendment to the French-Luxembourg tax treaty that will significantly impact the investment structures involving Luxembourg vehicles holding French real estate assets.

This amendment, signed early in September, will come into force once the ratification process by the respective parliaments of both countries has been completed – in any case, not before 1 January 2015. In practice, if the ratification process is completed before 30 November 2014, the new provisions will apply as from 1 January 2015. If the ratification process is completed after 30 November 2014 but before 30 November 2015, the provisions will apply as from 1 January 2016. Although few examples of tax treaty modifications never ratified exist, a step back in this case seems unlikely.

The amendment to the French-Luxembourg tax treaty adds a new paragraph 4 to Article 3 of the treaty, pursuant to which gains derived by a Luxembourg company from the disposal of shares in an entity (such as a company, trust or institution) whose assets predominantly (i.e. for more than 50 percent) consist directly or indirectly in French real estate assets, or which derives most of it value from French real estate assets, are taxable in France.

The structure involving a Luxembourg company, which holds a French entity (company or partnership), which in turn owns the asset, is quite typical for inbound investments in French real estate assets.

Pursuant to the current version of the treaty, the disposal of the French entity by the Luxembourg holding company can be achieved free of French and Luxembourg capital gains tax. Once the amendment to the treaty will have come into force, the gain recognized on the disposal of the French entity will be subject to French capital gains tax at the rate 33.33 percent (increased by additional contributions under certain conditions).

The amendment does not include a grandfathering clause. It will therefore impact existing investment structures.

It however provides for certain exceptions, in particular:

• for entities whose real estate assets are allocated to their own business activity as opposed to a rental activity; (such assets will not be taken into account to appreciate the 50 percent test)
• in case of mergers, divisions, transfers of assets and exchanges of shares involving companies that are resident of an EU member state and
• in case of transfer of the registered office of a European Company within the EU.

Investors should consider whether there is a way to restructure their existing investments or at least to achieve a step-up in the value of the assets prior to the entry into force of the amendment.

Core (long-term) investors, may, for instance, consider a French OPCI as an alternative. OPCIs are French regulated investment vehicles dedicated to real estate, the purpose of which is to acquire or construct buildings for renting, and/or holding shares in companies with similar object. Subject to compliance with asset allocation ratios and with distribution obligations, OPCIs are fully exempt from corporate income tax in France. OPCIs furthermore benefit from the provisions of the French-Luxembourg tax treaty, including the 5 percent reduced WHT rate on dividend distributions (under certain conditions). Although the French and Luxembourg governments announced that they will continue discussions to improve the tax treaty, to the best of our knowledge there is no indication at this stage of a change of the OPCI treatment.

Any reorganization plan of existing Luxembourg/French real estate structures should be carefully analyzed as it will likely be scrutinized by the French tax authorities.