PDF Protocol to France-U.S. Tax Treaty - Sullivan & Cromwell

[Pages:8]February 9, 2009

Protocol to France-U.S. Tax Treaty

France and the United States Sign a Protocol Amending the Income Tax Treaty

SUMMARY

On January 13, 2009, France and the United States signed a protocol (the "Protocol") amending the income tax treaty signed by the two countries in 1994, as amended by a 2004 protocol (the "Existing Treaty").

The Protocol generally eliminates withholding tax on dividends paid to shareholders holding at least 80% of the distributing company and generally eliminates the branch profits tax. It also eliminates withholding on royalties for the use of intangible property. The Protocol provides for mandatory arbitration of certain cases that are not resolved by the competent authorities within a specified period of time, clarifies the treatment of certain fiscally transparent and pass-through entities, imposes stricter requirements for certain companies to qualify for the benefits of the treaty, and updates the rules for the exchange of taxpayer information between the tax authorities of each country. These changes will align the Existing Treaty more closely with more recent U.S. tax treaties.

The Protocol will enter into force upon ratification by both countries and apply (i) in respect of withholding taxes, to payments made on or after January 1 of the year in which the Protocol enters into force, and (ii) in respect of other taxes, for taxable periods beginning on or after the January 1 following the date on which the Protocol enters into force. Thus, assuming ratification in 2009, the withholding tax changes will apply to payments made after January 1, 2009 and the other changes made by the treaty for taxable periods after January 1, 2010. There is no grace period for situations in which the Protocol adversely affects a taxpayer ? for example, a corporation excluded from treaty benefits because of the tightened "Limitation on Benefits" article.

New York Washington, D.C. Los Angeles Palo Alto London Paris Frankfurt Tokyo Hong Kong Beijing Melbourne Sydney

DISCUSSION

DIVIDENDS, BRANCH PROFITS TAX AND ROYALTIES Dividends and branch profits tax. In addition to continuing the reduced withholding tax rates of 15% and 5% applicable to dividends in the Existing Treaty, the Protocol provides for an exemption from withholding tax for dividends if the beneficial owner is a company resident of the other country that owns, directly or indirectly through companies that are residents of either France or the United States, at least 80% of the share capital of a French paying company or 80% of the voting rights of a U.S. paying company, in either case for a twelve-month period ending on the date on which entitlement to the dividends is determined.

Consistent with the elimination of withholding tax on parent-subsidiary dividends, the Protocol reduces the rate of branch profits tax to zero. There may be a divergence of views between the U.S. and France as to whether the branch profits tax is a withholding tax whose elimination takes effect on January 1 of the year of ratification or is not a withholding tax and therefore whose elimination will take effect on January 1 of the year following ratification.

The exemption from withholding tax is limited to dividends paid to companies of the other country that qualify under specific provisions of the "Limitation on Benefits" article ? generally, those companies that meet the publicly-traded test, qualify as subsidiaries of publicly-traded corporations, meet the ownership and base erosion tests and derive the dividends in connection with, or as an incident to, a trade or business carried on in its country of residence or qualify under the "Limitation on Benefits" article by virtue of a competent authority determination. The same restrictions apply to the rule that eliminates the branch profits tax.

The Protocol continues the 15% rate that applies to dividends paid by a U.S. "real estate investment trust", or REIT, to an individual shareholder owning 10% or less of the REIT, and extends the 15% rate to dividends paid by a REIT to a shareholder that is a pension or like plan owning 10% or less of the REIT, dividends paid on a class of publicly traded shares to a shareholder who owns 5% or less of any class of shares of the REIT, and dividends paid to a shareholder owning 10% or less of the REIT if the REIT is "diversified".1 Under the same circumstances (except that there is no "diversification" requirement), the 15% rate applies to dividends paid by a French soci?t? d'investissetments immobiliers cot?e, or SIIC, and by a French soci?t? de placement ? pr?pond?rance immobili?re ? capital variable, or SPPICAV, to a

1 A REIT is diversified if no single real property interest is more than 10% of its total interests in real property, excluding foreclosure property.

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U.S. shareholder. Thus, the zero and 5% withholding tax rates will not be available to dividends paid by a REIT, a SIIC or a SPPICAV.

Royalties. The Protocol eliminates withholding tax on royalties for the use of intangible property, as well as on gains from the disposition of intangible property that are contingent on the productivity, use or disposition of the property. The rate under the Existing Treaty is 5%.

LIMITATION ON BENEFITS The Protocol would tighten some of the tests that apply to determine whether a company qualifies for treaty benefits under the "Limitation on Benefits" article.

Publicly-traded test. Under the Existing Treaty, a company is entitled to the benefits of the treaty if any one of the following conditions applies:

(1) its principal class of shares is listed on a recognized securities exchange located in either France or the U.S. and is substantially and regularly traded on one or more recognized stock exchanges;

(2) more than 50% of its shares, by vote and value, is owned, directly or indirectly, by any combination of

a. companies resident in either France or the U.S., the principal classes of the shares of which are listed on a recognized securities exchange located in either France or the U.S. and regularly traded on one or more recognized stock exchanges;

b. a French or U.S. governmental authority or agency; and

c. companies 50% or more owned, by vote and value, by a French or U.S. governmental authority or agency;

(3) at least 30% of its shares, by vote and value, is owned, directly or indirectly, by any combination of

a. companies resident in its state of residence, the principal class of the shares of which are listed on a recognized securities exchange located in either France or the U.S. and substantially and regularly traded on one or more recognized stock exchanges;

b. a French or U.S. governmental authority or agency; and

c. companies 50% or more owned, by vote and value, by a French or U.S. governmental authority or agency; and

at least 70% of the aggregate vote and value of its shares is owned, directly or indirectly, by any combination of (i) companies resident in either France or the U.S. or in one or more member

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states of the European Union, the principal classes of shares of which are listed and substantially and regularly traded on one or more recognized stock exchanges, (ii) a French or U.S. governmental authority or agency, (iii) one or more member states of the European Union, political subdivisions or local authorities thereof, or agencies or instrumentalities thereof, and (iv) companies of which more than 50% of the vote and value is owned by such European Union member states or agencies or instrumentalities.

Under the Protocol, the requirements of the first condition described above would be tightened into a prerequisite that a company's principal class of shares and any disproportionate class of shares be regularly traded on one or more recognized stock exchanges, and it would further require that either the company's principal class of shares be primarily traded on a recognized stock exchange located in its state of residence (or, in the case of a French company, on a recognized stock exchange within the European Union, or, in the case of a U.S. company, on a recognized stock exchange located in a state party to the North American Free Trade Agreement ("NAFTA")) or that its primary place of management and control be in its state of residence. The shareholding test of the second condition described above would also be changed. The new test would require: (i) that at least 50% of the aggregate vote and value of the company's shares and at least 50% of any disproportionate class of shares be owned, directly or indirectly, by the relevant class of French or U.S. publicly-traded companies and governmental entities, (ii) for purposes of applying this 50% test, the test must be satisfied with respect to shares held directly or indirectly by no more than 5 companies or governmental entities, and (iii) that for purposes of counting shares indirectly owned by a French or U.S. resident company or governmental entity, any intermediate entity through which the shares are held must also be a resident of France or the U.S. The third option has been removed under the Protocol.

General Ownership Test.

Under the Existing Treaty, a person (other than an individual) would be

entitled to the benefits of the treaty if 50% or more of its beneficial interest (or, in the case of a company,

50% or more of the vote and value of the company's shares) is not owned, directly or indirectly, by

persons that are not "qualified persons" (i.e., citizens of the U.S. or persons generally entitled to the

benefits of the treaty) and, under a "base erosion" test, either (1) less than 50% of the gross income of

such person is used, directly or indirectly, to make deductible payments to persons that are not qualified

persons, or (2) less than 70% of such gross income is used, directly or indirectly, to make deductible

payments to persons that are not qualified persons and less than 30% of such gross income is used,

directly or indirectly, to make deductible payments to persons that are neither qualified persons nor

residents of member states of the European Union.

The Protocol clarifies that the 50% ownership test is required to be satisfied on at least half the days of the taxable year and applies to any "disproportionate class" of shares. A "disproportionate class of shares" for this purpose means any class of shares of a company resident in one state that entitles the

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shareholder to disproportionately higher participation, through dividends, redemption payments or otherwise, in the earnings generated in the other state. It also restricts the applicable definition of "qualified persons" to include individuals, a French or U.S. governmental authority or agency, companies qualifying under the publicly-traded test, and qualifying pension trusts. In a change from the Existing Treaty, the Protocol generally does not count U.S. residents for purposes of determining whether a French entity meets the test, or French residents for purposes of determining whether a U.S. entity meets the test, and requires any intermediate owner of shares also to be a resident of France, in the case of a French entity, or the U.S., in the case of a U.S. entity. The "base erosion" test under the Protocol eliminates the second option. Arm's-length payments in the ordinary course of business for services or tangible property and payments in respect of financial obligations to an unrelated bank are excluded from the determination under the modified base erosion test.

EU or NAFTA Company Ownership Test. The Protocol adds a new qualification test under the "Limitation on Benefits" article that allows a company resident in France or the U.S. to be eligible for treaty benefits if at least 95% of its shares, by vote and value (and at least 50% of any disproportionate class of its shares) is owned, directly or indirectly, by no more than seven "equivalent beneficiaries" (i.e., a EU or NAFTA resident that would satisfy the requirements under the "Limitation on Benefits" article under the treaty applicable with France, in the case of the EU, or the U.S., in the case of NAFTA (or, if such treaty has no such clause, would meet the requirements of the France-U.S. treaty)) and, under a modified base erosion test, its aggregate deductible payments to non-equivalent beneficiaries for the year is less than 50% of its annual gross income.

Other Changes.

? The Protocol eliminates a provision in the Existing Treaty that allows a French or U.S. resident to avail of the benefits of the treaty if the resident functions as a headquarter company for a multinational corporate group.

? The Protocol eliminates a provision in the Existing Treaty that allows a French or U.S. company to avail of the benefits of the treaty with respect to dividends, interest or royalties if more than 30% of its shares, by vote and value, are held by qualified persons, more than 70% of such shares are owned, directly or indirectly, by any combination of one or more qualified persons and persons resident in the European Union and if such company meets the "base erosion" test described above.

? The Protocol retains the provision that a resident of one state will be entitled to the benefits of the treaty with respect to income derived from the other state if attributable to the active conduct of a business or trade in the state of the residence and such trade or business is "substantial" in relation to activity that generated the income in the other state. The Existing Treaty has a

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detailed test for determining whether the trade or business is "substantial" for this purpose; the Protocol replaces this test with a generic facts-and-circumstances test.

? The Protocol clarifies that, in determining whether a person is "engaged in the active conduct of a trade or business" for this purpose, activities conducted by a person "connected" to the taxpayer will be attributed to the taxpayer. A person shall be connected to another person for this purpose if one possesses at least 50% of the beneficial interest in the other (or, in the case of a company, at least 50% of its beneficial interest, by vote and value), or another person possesses, directly or indirectly, at least 50% of the beneficial interest (or, in the case of a company, at least 50% of the beneficial interest, by vote and value) in each person, or if, based on all the relevant facts and circumstances, the persons are under common control.

? The Existing Treaty turns off the benefits of the tax treaty with respect to income derived by a French or U.S. resident where the income is attributable to a permanent establishment held in a third jurisdiction if the combined tax paid with respect to such income in the state of residence and the third jurisdiction is less than 60% of the tax that would have been payable in the state of residence if the income were not attributable to a permanent establishment. The Protocol carves out royalties received as compensation for the use of intangible property produced or developed by the permanent establishment from this rule. A carve-out that existed under the Existing Treaty for Subpart F income and Subchapter N income, with respect to U.S. taxes, and French CFC rules (Article 209B of the French Tax Code) has been removed under the Protocol.

ARBITRATION Under the Protocol, where, pursuant to the mutual agreement procedures under the treaty, the competent authorities are unable to reach agreement with respect to a particular case that has been brought before them, the case shall be resolved through arbitration. This mandatory arbitration procedure will not be applicable if the competent authorities agree that it is not "suitable for arbitration". In addition, a case will not be subject to arbitration if a decision has been rendered by a French or U.S. court or administrative tribunal.

If a concerned person does not accept the determination of the arbitration panel, the determination will not be binding; otherwise, the determination shall constitute a resolution by mutual agreement under the treaty and shall be binding on both France and the U.S.

PARTNERSHIPS AND OTHER "FISCALLY TRANSPARENT" ENTITIES The Protocol provides that an item of income from one country (the "source" country) earned by an entity that is "fiscally transparent" for either French or U.S. tax purposes will be eligible for treaty benefits in the source country if (1) the entity is organized in France, the U.S. or a country with which the source country has a tax treaty or other international agreement that provides for exchange of taxpayer information and

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(2) the item is treated as the income of a resident of the other country (i.e., France or the U.S., as the case may be).

Under current French domestic law, an item of income earned by a partnership is not "treated as the income of the partner" since France does not recognize the full transparency of partnerships2. Therefore, this provision is not applicable to income received by a French resident through a partnership.

However, the Protocol specifically provides that U.S. source income of a French qualified partnership3 is eligible for treaty benefits to the extent the item is included in the income of a member of the partnership on a current basis and the member is a resident of France.

OTHER CHANGES IN THE "LIMITATION ON BENEFITS" ARTICLE ? The Protocol provides that French SIICs and SPPICAVs qualify as residents of France for treaty purposes.

? The Existing Treaty provides that French or U.S. social security payments to a resident of the other country are subject only to source-country taxation. The Protocol clarifies that this rule also applies to social security payments made to U.S. citizens resident in France.

? Certain provisions of the "Exchange of Information" article have been strengthened to facilitate information exchange between the two countries.

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2 France has an unusual approach to partnerships, under which a partnership is viewed as liable to tax with respect to its income, even though the corresponding income tax is effectively collected at the level of the members. Such income is treated as the income of the partnership, not the income of the members. The French tax administration contemplates a reform of French domestic law in order to recognize the concept of "transparency" adopted by most other OECD countries.

3 A partnership is a "qualified partnership" for this purpose if it is effectively managed in France, has not elected to be taxed in France as a corporation, computes its tax base at the partnership level for French tax purposes, and if all of its members, shareholders or associates are, under French tax law, subject to French taxation with respect to their profits from the partnership.

Copyright ? Sullivan & Cromwell LLP 2009

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