An illustration of the different tax effects based on the same legal basis of the elimination of the double taxation : different tax effects according to the taxable person residence
Tax treaties are international treaties designed to prevent taxpayers – companies or individuals – from being taxed twice on the same income by two different countries, and also to combat tax evasion and avoidance.
A country’s tax system may include rules imposing higher taxation on foreigners. Many tax treaties between FRANCE and other countries include a non-discrimination clause based on nationality. Thanks to this clause, foreign taxpayers will be treated in the same way as nationals of their country of residence, who are in a comparable tax situation.
An exemplary illustration will be given of the principle of eliminating double taxation and its different effects between different countries. The legal basis of elimination of the double taxation is the same but the tax effects are different according to the country of the residence of the taxable person.
Two methods exist for eliminating double taxation. These are the exemption method, which can be total or progressive, and the imputation method, which can also be total or ordinary.
FRANCE has the most extensive network in the world, with 121 bilateral tax treaties. The majority of international tax treaties signed by FRANCE are based on the Organization for Economic Cooperation and Development (“Organisation de coopération et de développement économiques”) (OECD) model, which provides different definitions of the concepts of stable establishment or residence and sets out tax rules for the taxation of income and wealth.
Tax treaties are negotiated by the Tax Legislation Directorate (“Direction de la législation fiscale »)(DLF), in conjunction with the Ministry of Europe and Foreign Affairs, which plays a secondary role. The International Legal and Economic Expertise Mission (“Mission d’Expertise Juridique et Économique Internationale”) (MEJEI), located within the Public Finance Department (“Direction Générale des Finances Publiques”) (DGFiP), is responsible for ensuring that tax treaties are properly applied. However, each tax treaty between FRANCE and another country imposes different requirements.
Below, it will be analyzed the tax treaties between FRANCE and three other countries: UNITED STATES, HONG-KONG and RUSSIA.
1. Tax treaty between FRANCE and the UNITED STATES concerning taxes on income and wealth.
An agreement for the avoidance of double taxation and the prevention of fiscal evasion and fraud with respect to taxes on income and capital was signed on August 31, 1994, in PARIS between the Government of the French Republic and the Government of the UNITED STATES of America. It is accompanied by a protocol and an exchange of letters forming an integral part of the agreement.
This agreement replaced the agreement signed on July 28, 1967, amended by the protocols of October 12, 1970, November 24, 1978, January 17, 1984, and June 16, 1988, including the exchanges of notes or letters annexed.
The article 33 of the agreement provides that the provisions of the agreement shall apply:
“a) with respect to withholding taxes on dividends, interest and royalties, and U.S. excise taxes on insurance premiums paid to foreign insurers, to amounts paid on or after February 1, 1996.
b) with respect to income taxes, to tax periods beginning on or after January 1, 1996.
c) as regards taxes not mentioned above, to taxable events occurring on or after January 1, 1996.
d) Notwithstanding the foregoing:
– the provisions of e of paragraph 4 of article 10 (dividends) and those of article 12 (royalties) shall apply to dividends and royalties paid on or after January 1, 1991.
– for mutual agreement procedures under Article 26 of the Convention, to cases submitted to the competent authorities on or after December 30, 1995”.
Persons covered by the agreement
Unless the convention provides otherwise, the persons concerned are residents of FRANCE and the UNITED STATES, namely any person subject to tax by reason of their domicile, their residence, their registered office. management, its head office or any other criterion of a similar nature. Green card holders are also affected.
Determination of tax residence
In the event of a residence conflict, it is resolved by successively applying the criteria retained by the convention, namely: The permanent home, the center of vital interests, the usual place of stay, the nationality, the agreement of the competent authorities of the two countries.
The conflict of residence is decided by the competent authorities who take into account the place of effective management of this person, their registered office and any other relevant element. In the absence of such agreement, such person shall not be considered a resident of either Contracting State for the purposes of granting the benefits of the Convention.
Taxation of individuals
Remuneration from salaried employment is, conventionally, taxable in the State in which the professional activity is carried out (except in the case of temporary assignments). Pensions are taxable in the state of source.
Real estate income is taxable in the state where the building is located. Dividends are taxable in the state of residence of the beneficiary but may be subject to withholding in the state of source which cannot exceed 15% of the gross amount of these dividends. Interest is taxable in the beneficiary’s state of residence. Real estate capital gains are taxable in the state where the building is located. Capital gains from the sale of shares or units are taxable in the state of residence of the beneficiary. Particularity concerning American nationals who are tax residents of FRANCE, as an exception, the dividends, interest and capital gains on the sale of securities from American sources that they receive are taxable in the UNITED STATES.
The article 23 of the convention deals with wealth tax, but also applies to real estate wealth tax (“impôt sur la fortune immobilière” (IFI), as confirmed by the French tax administration.
This provision provides for the taxation of wealth constituted by real estate in the State in which the property is located.
It also provides that natural persons of American nationality who do not have French nationality and who become residents of FRANCE are exempt from wealth tax for the 5 years following those of their installation in FRANCE, for assets only. held outside FRANCE.
The convention uses the criterion of permanent establishment allowing profits from a commercial or industrial activity to be taxed at the place of exercise of these activities and not at the place of residence of the company. Thus, in the case of a company established in FRANCE which carries out all or part of its activity in the United States where it has a permanent establishment, the results resulting from this activity and attributable to the permanent establishment will be taxable to the UNITED-STATES.
A permanent establishment is defined as an installation with a certain permanence. This may include a management headquarters, a Branch or an office.
Elimination of double taxation
As a reminder, the tax convention distributes the right to tax income between FRANCE and the UNITED STATES. However, as a tax resident of a country, this person must declare all of their income there. Likewise, American nationals, even if they are residents of another country, must declare all of their income in the United States. The France-United States convention uses the tax credit (“crédit d’impôt”) as a method of eliminating possible double taxation.
System to combat tax evasion and fraud
Finally, the agreement has an administrative assistance clause with a view to combating tax fraud and evasion, as well as a mutual assistance clause in matters of recovery allowing for an automatic suspension of payment and not having to provide guarantees for those liable for the exit tax when they leave FRANCE.
Tax allocation under the tax treaty
Where it gets a little more complicated is that the treaty gives the right to tax differently depending on the nature of the income. Sometimes, only the taxpayer’s state of residence will be able to tax, sometimes the state of income, sometimes the right will be attributed to both, and this is where the tax credit mechanism comes into play.
To simplify matters, here are a few rules to bear in mind (note that there are often exceptions):
- Salaries, wages, annuities received from salaried employment: taxable in the state where the activity is generated ;
- Self-employed activities: taxable in the state of residence ;
- In the case of wealth tax, if you are an American tax resident, you are not taxable in the United States and you will only be taxable in France if your French wealth is equal to or greater than 1.3 million euros (excluding financial investments) ;
- Dividends: a priori taxable in both states, but with a ceiling in the source state.
Furnished rental regime
Income from a furnished rental activity falls under the category of industrial and commercial profits (“bénéfices industriels et commerciaux”) (BIC). The tax regime applicable to this income when it is taxable must be determined under common law conditions (micro-BIC, self-employed, simplified regime or normal real regime). Professional furnished rental companies must keep commercial accounts and comply with all reporting and accounting obligations imposed on businesses.
To sum up, persons not domiciled in FRANCE must in principle pay a tax which cannot be less than 20% of taxable income. However, if a taxpayer manages to justify that the average rate of French tax on all of this income from French and foreign sources is lower than the minimum rate of 20% then he will be taxed at this average rate on his income alone.
2. Tax convention between FRANCE and HONG-KONG
FRANCE and the HONG-KONG Special Administrative Region of the People’s Republic of China signed an agreement in Paris on October 21, 2010, for the avoidance of double taxation regarding to taxes on income and the prevention of fiscal evasion and avoidance.
Persons covered by the agreement
This agreement applies to people who are residents of FRANCE and HONG-KONG under the internal law of each country.
However, the protocol specifies that a tax resident of one of the countries cannot benefit from the provisions of the convention, since he carries out his professional activities in a free zone.
On the other hand, a resident benefiting from a specific tax regime allowing him to be taxed only on income originating in this country benefits from the convention.
Determination of tax residence
Natural persons benefit from this agreement. However, in the event of a residence conflict, it can be resolved by successively applying the criteria retained by the convention, namely, the permanent home, the center of vital interests, the usual place of stay, the nationality for FRANCE or the right of residence for HONG-KONG and the agreement of the competent authorities of the two countries.
They are considered tax residents of the country in which their effective place of management is located.
Taxation of individuals
Remuneration from salaried employment is, conventionally, taxable in the State in which the professional activity is carried out.
Real estate income is taxable in the state where the building is located. Dividends are taxable in the state of residence of the beneficiary. However, they may be subject to withholding in the State of source, which cannot exceed 10% of the gross amount of these dividends. Interest is also taxable in the state of residence of the beneficiary. However, the State of source may also make a deduction, which may not exceed 10% of the gross amount of interest.
Real estate capital gains are taxable in the state where the building is located. Capital gains from the transfer of shares or shares are taxable only in the state of residence of the beneficiary except in the case of substantial participation, where the capital gain is then taxable in the state of residence of the company.
The agreement signed with HONG- KONG includes a provision relating to the wealth tax, a tax in force at the time of its drafting and must also apply to the real estate wealth tax (“impôt sur la fortune immobilière”) (IFI). This provision distributes the right to tax wealth between the two countries. It provides in particular for the taxation of wealth constituted by real estate in the State of location of the property.
The convention uses the criterion of permanent establishment allowing profits from a commercial or industrial activity to be taxed at the place of exercise of these activities, and not at the place of residence of the company. Thus, in the case of a company established in FRANCE which carries out all or part of its activity in HONG-KONG where it has a permanent establishment, the results from this activity and attributable to the permanent establishment will be taxable in HONG- KONG. A permanent establishment is defined as an installation with a certain permanence. This may include a management headquarters, a branch, or an office.
Elimination of double taxation
In FRANCE, the method for eliminating double taxation is tax credits (“crédit d’impôt”)
The tax credit is an amount deducted from your income tax. If the tax credit exceeds the amount of your income tax, the surplus is reimbursed by the Public Finance Department (“Direction Générale des Finances Publiques”).
System to combat tax evasion and fraud
The convention includes a provision relating to the exchange of information. This provision authorizes the communication of information, including banking information. However, only detailed requests can be made by the tax authorities, in order to avoid spontaneous or automatic “fishing for information”.
3. Tax treaty between FRANCE and RUSSIA
An agreement for the avoidance of double taxation with respect to taxes on income and capital was signed on November 26, 1996, in PARIS between the government of the French Republic and the government of the Russian Federation. It is accompanied by a protocol forming an integral part of the agreement.
Specifically, the article 28 of the agreement provides that the stipulations it contains apply:
“a) with regard to taxes collected by withholding tax;
(b) in relation to other income taxes, to income relating to any tax period
c) with regard to other taxes, to taxes for which the taxable event will occur from January 1, 2000”.
The delegations of France and Russia met on January 22, 2001, with a view to resolving the difficulties in applying the tax convention of November 26, 1996.
This delegation dealt with the definition of construction sites as permanent establishments, the application of a withholding tax on dividends under the tax system, and the deductibility of certain expenses. The negotiations took place in an atmosphere of friendship and mutual understanding.
Persons covered by the agreement
The Convention applies to persons who are residents of one or both States.
As far as FRANCE is concerned, these are income tax, corporate tax, payroll tax and wealth solidarity tax (“l’impôt de solidarité sur la fortune”) (ISF). As far as RUSSIA is concerned, these are the tax on profits of enterprises and organizations (including tax on salaries exceeding the established norm), tax on personal income, tax on business property and personal property tax. Russia has not introduced a wealth tax.
Real estate wealth tax
The real estate wealth tax (“impôt sur la fortune immobilière”) (IFI) is restricted to buildings and real estate rights held by the taxpayer, directly or through a company or an organization.
In the administrative comments relating to this new tax, on June 8, 2018, the French tax administration specified in a remark that the principles guiding the interpretation of the provisions of the tax conventions used in matters of ISF are taken up in terms of IFIs. The fact remains that a convention applicable to the ISF is not, however, applicable to the IFI, a case-by-case examination of the conventional stipulations being necessary.
Deductibility of expenses
Differences of interpretation persist between the French and Russian parties on the application of the rules for deducting various types of expenses when calculating the industrial and commercial profit made by a permanent establishment located in RUSSIA of a company incorporated under French law, or by a subsidiary located in RUSSIA of a French company.
The French side considers that, in application of the provisions of the Franco-Russian agreement of November 26, 1996, operating expenses incurred by a permanent establishment or subsidiary meeting the conditions are fully deductible in determining its income, provided that this deduction does not exceed the amount that would have been agreed in the absence of special relations between the debtor and the effective beneficiary of this income.
The Russian party points out, however, that the ceiling for deducting expenses relating to representation, advertising and training has been substantially raised since April 1, 2000.
In this respect, it points out that since the ceiling was raised, it has not been informed of any new cases of litigation brought by companies.
In any case, the Russian party is willing to examine, on a case-by-case basis, within the framework of the amicable procedure provided for in article 25 of the agreement, any difficulties arising from the application of these limitations.
The Russian party, for its part, considers that while domestic legislation permits the deduction of special expenses from taxable profits within certain limits. At the same time, it has been confirmed that regardless of the provisions of domestic legislation, interest is deducted from taxable profits, irrespective of the status of the lender and the terms and conditions of the credit giving rise to the interest payment. The only limitation on interest deductibility is the maximum interest rate. However, there is a huge update in this particular convention as RUSSIA suspends key provisions of double taxation agreement with FRANCE and other “unfriendly” states.
On August 8, 2023, the Russian President issued a decree, which unilaterally suspends – on the part of the Russian counterpart – most of the substantive provisions of the double taxation avoidance agreements concluded between RUSSIA and the so-called unfriendly states which have imposed sanctions on RUSSIA.
The appeal concerns 38 double taxation avoidance agreements, including the one concluded with FRANCE on November 26, 1996. The suspension is effective from August 8, 2023, until the unfriendly states remedy their violations of RUSSIA’S legitimate economic and other interests, the rights of its nationals and legal entities, or until the termination of these international treaties with respect to Russia. The suspension was legally adopted under the Russian Federal Law on International Treaties, which authorizes the President, in situations requiring urgent measures, to suspend the effect of an international treaty that has been ratified by federal law.
Although the decree mentions the need to take urgent measures due to the unfriendly actions of a number of states (sanctions), as required by Russian federal law, this may be insufficient to serve as grounds for unilateral suspension from the point of view of international law. This latter point may be one of the factors to be taken into account by so-called unfriendly states when devising their retaliatory measures.