Renegotiation of The France-Luxembourg Tax Treaty Targets Capital Gains on French Real Estate Companies

February 7, 2012

***FOR 2014 UPDATE, please see "Renegotiation of the France and Luxembourg Tax Treaty: Taxation of Real Estate Capital Gains Now Expanded by Way of a September 5, 2014 Amendment to the Treaty" (Gibson Dunn update, September 8, 2014).   

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The French tax authorities have announced their decision to renegotiate the France-Luxembourg tax treaty. Such renegotiation is going to impact many investors holding French real estate investments through Luxembourg entities.

Current Double-Exemption Situation under the France-Luxembourg Tax Treaty

Under French domestic tax law, capital gains earned  by a foreign resident company from the sale of shares in a French real estate property company (e.g., an SAS, SA, SARL or SCI) are generally taxable in France. Such gains are subject to a withholding tax, the rate of which usually amounts to 33.33%.

This domestic tax regime applies subject to the provisions of relevant tax treaties, which may deny France’s right to tax any capital gains realized upon the disposal of shares, including those of French real estate property companies.

As one notable example, the France-Luxembourg tax treaty does not include any specific article dealing with capital gains. Thus, capital gains enter into the scope of Article 18 of the tax treaty relating to "Other Income". As such, such capital gains may be taxed only in Luxembourg if the holder of the French shares is a Luxembourg company.

This reasoning has not been altered by the France-Luxembourg Amendment signed on November 24, 2006. This Amendment ended a double exemption situation by providing that Luxembourg companies are taxable in France on rental income and capital gains derived from directly held French real estate property. However, the Amendment does not give France the right to tax gains on the disposal of shares in French real estate property companies held by Luxembourg companies[1].

As a result, gains on the sale of shares in real estate property companies are exempt in France (assuming the Luxembourg holding company has no permanent establishment in France) and are, most often, exempt in Luxembourg too, pursuant to the Luxembourg participation exemption regime or, as far as the disposal of French SCIs is concerned, as a result of the Luxembourg domestic law.

Consequences of The Renegotiation of The France-Luxembourg Tax Treaty

The French tax authorities have announced their decision to renegotiate the France-Luxembourg tax treaty in order to be attributed the right to tax capital gains on shares held in French real estate property legal entities by Luxembourg tax residents. The official reaction of the Luxembourg tax authorities and the possible timing of such renegotiations are not yet known, although the French tax authorities apparently wish to act quickly.

Assuming that the new wording of the France-Luxembourg tax treaty would be similar to the provisions of recent tax treaties entered into by France, any transfer of shares held by a Luxembourg tax resident in a French entity predominantly holding French real estate (directly or indirectly) would become subject to capital gains tax in France.

Such a change would materially impact many real estate ownership structures implemented by non-French investors in order to hold their French real estate investments. This change would confirm the recent trend of the French tax authorities to amend French tax law in order to make the ownership of French real estate investments through a French legal entity less  attractive (in addition to increasing taxes on French real estate income and capital gains).

Appropriate restructurings of French real estate investments being held through Luxembourg should be considered in order to anticipate the entry into force of the amended France-Luxembourg tax treaty.

Clients should consider contacting us in preparation for this change in order to benefit from our experience of existing alternative investment and holding structures.