New double tax treaty between Luxembourg and France: what is the impact for private equity investments?
“A proper transfer-pricing analysis plays a key role”
by Vincent Lebrun (Private Equity Leader) and Nicolas Sansonnet (Director), PwC Luxembourg
On 20 March 2018, the Luxembourg and French Governments signed a new double tax treaty (DTT), together with an accompanying protocol.
The primary impact of this new DTT relates to real-estate investments structured with an “OPCI” incorporated in the form of a “SPPICAV”. However, you may be wondering whether this new DTT has an impact on private equity investments.
In our view, there are two key factors in this respect: i) the updated concept of “residency” (Article 4 of the DTT); and ii) the inclusion of a “principal purpose test” (Article 28 of the DTT).
- Residency: The current DTT uses the concept of managed and controlled entity rather than the tax status of the resident. With the new DTT, a resident is defined as a person “subject to tax”.
- Principal purpose test: In line with OECD’s guidelines, the wording of this new DTT aims at disallowing the benefits of the DTT if it is reasonable to conclude, having regard to all relevant facts and circumstances, that obtaining the benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in that benefit, unless it is established that granting the benefit in these circumstances would be in accordance with the object and purpose of the relevant provisions of the DTT.
What are the concrete impacts when it comes to private equity investments?
Firstly, the new concept of residency would exclude certain tax-exempt vehicles that may be used in the private equity sector: in particular, this concerns SICAV specialised professional funds (“SICAV FPSs”), Luxembourg specialised investment funds (“SICAV SIFs”), and potentially SICARs for which full exemption is granted for income derived from assets presenting a “high-risk profile”. Secondly, with the inclusion of a principal purpose test, substance considerations and the concept of beneficial ownership gain in importance. Where a Luxembourg investment structure is used to invest in French private equity assets, this requires having the right allocation of functions in Luxembourg (i.e. ability and power to take decisions), as well as seeking a diversification of assets and incurring financial risks. A proper transfer-pricing analysis plays a key role in documenting these factors. However, in that sense, and conversely to a real-estate structure, the new DTT does not bring any new groundbreaking measures; rather, it follows a current trend in the international tax environment. It provides a legal basis for the tax authority to make sure that holding and financing companies are implemented and used with a true business rationale.
More technical details on the new DTT can be found here.