Recent Developments Impacting Inbound and Outbound Income Flows – Part I
France withholds tax on various types of income flows accruing to non-resident recipients. Like elsewhere, the applicable withholding tax may be impacted by tax treaties or EU law. In recent years, however, the complexity of the applicable rules has increased exponentially with on the one hand the introduction of multiple anti-avoidance rules, and on the other hand several national and EU judicial rulings with far-reaching consequences. One of such consequences is the determination of the applicable withholding tax rate when the non-resident recipient of an item of income is not the beneficial owner thereof. Furthermore, when the applied withholding tax is subsequently found to conflict with national or EU law, the question arises as to whether the faulty withholding tax assessment should be scrapped entirely, or only sufficiently adjusted to eliminate the underlying conflict. In the mirror image, French residents in receipt of foreign-source qualifying dividends and capital gains are eligible to a participation exemption regime. Hitherto, the automatic corollary of the regime is that any foreign tax credits attached to the income received are entirely forfeited. Or are they?
This article addresses the consequences of three recent French Supreme Administrative Court rulings dealing respectively with (a) the applicable withholding tax rate when the non-resident apparent recipient of the income is not the beneficial owner thereof, (b) the consequences of applying a withholding tax rate that is subsequently found to be in conflict with national or EU law, and (c) the availability or not of a foreign tax credit with respect to foreign-source income benefiting from the French participation exemption regime. It is presented in two parts: Part I in this Expert Corner edition and Part II in a forthcoming edition.
Part I: Withholding Tax and Beneficial Ownership: Attention! Un Train Peut En Cacher Un Autre!1
Unless a treaty or EU law provide otherwise, France applies a withholding tax at the rate of 25% (33.33% previously) on French-source royalties paid to non-residents. The rate is increased to 75% if the recipient is established in a blacklisted non-cooperative jurisdiction.
The application of withholding tax relief pursuant to the provisions of a tax treaty is subject to the condition that the recipient is covered by the relevant treaty and is the beneficial owner (“bénéficiaire effectif” in French) of the income. The beneficial ownership condition appears to be of a universal application in France. Indeed, even though missing in some of France’s older tax treaties, the French Supreme Court has traditionally considered that the condition must be implicitly read in the treaty even if not explicitly spelled out therein. The concept of beneficial ownership itself is not clearly defined under the French statutes. Following several successive changes, the Commentaries to the OECD Model Tax Convention now stipulate that the term should not be read in a narrow technical sense, but instead should be understood in its context and in light of the object and purposes of the Convention, including avoiding double taxation and the prevention of fiscal evasion and avoidance. The Commentaries, therefore, deny treaty benefits for merely interposed agents and nominees, and reserve this right to the actual beneficial owner, defined as the person who has the right to use and enjoy the payment received, without being constrained by a contractual or legal obligation to pass on the payment received to another person. This unconstrained right of use and enjoyment approach seems to have been adopted by the French Supreme Court after a period of inconsistent judicial precedent. Hence, in its most recent case law on the matter (CE 5 February 2021, Performing Rights Society (PRS) Ltd, n° 430594), the Supreme Court struck down a ruling by the Court of Appeals and basically determined that a recipient who is practically constrained to pass on each year a substantial portion of the relevant income to other persons cannot be seen as the beneficial owner of that income.
The position of the Supreme Court in the PRS case, whilst in essence clarifying the situations in which a person may be denied treaty benefits on the grounds that it is not the beneficial owner, failed to clarify what happens next. Does the matter end with France applying the withholding tax under its domestic laws? Or is there an alternative avenue for the taxpayer such as claiming instead the benefits of the treaty with a third country where the actual beneficial owner is resident? The Supreme Court’s Planet decision (CE 20 May 2022, Société Planet, n° 444451) brought about a welcome clarification in this regard.
The Planet case is relatively convoluted and atypical. First of all, it dealt with two different issues: (a) the classification of the relevant income (either as royalties potentially subject to withholding tax under the treaty, or as service fees outside the scope of the treaty’s royalty article and thus not subject to withholding tax in France), and (b) the potential application of the benefits of the treaty with a third country instead of the benefits of the treaty with the country of the immediate recipient. The case started with payments by Planet France of -what later was determined to be- royalties to a New Zealand entity for the use of fitness programs. Planet France thereafter restructured its operations and started making the payments to interposed Belgian and Maltese entities without the deduction of withholding tax. The tax authorities took the position that the payments constitute royalties and not service fees. Further, they determined that the Belgian and Maltese entities to which the payments were made were not the beneficial owners thereof. As a result, they denied the granting of the withholding tax exemption for royalties otherwise available under the France-Belgium treaty (the tax authorities appear to have ignored the Malta part of the equation because the France-Malta treaty provides for a 10% withholding tax, just like the France-New Zealand treaty that they intended to apply in substitution, see below).
The role of the tax authorities typically ends here; they are basically in the business of determining whether or not the conditions for entitlement to relief under the treaty claimed by the taxpayer are met, and generally not in the business of devising an alternative relief claim for the taxpayer. In the Planet case, however, the tax authorities not only denied the granting of benefits under the treaty with Belgium as claimed by the taxpayer, but also atypically and spontaneously determined (probably through the exchange of information) that the actual beneficial owner of the payments is the New Zealand entity and applied the reduced 10% royalty withholding tax rate provided for under the France-New Zealand treaty. In the ensuing litigation, the lower tribunal ruled in favour of Planet and struck down the withholding tax. On appeal, however, the Court of Appeals of Marseille reinstated the 10% withholding tax on the grounds that the payment in question should be classified as a royalty as per the definition contained in Art. 12 of the France-New Zealand tax treaty. By thus doing, the Court of Appeals appeared to implicitly validate the determination by the tax authorities that the New Zealand entity is the actual beneficial owner of the payments.
In the ensuing litigation, the Supreme Court validated the application of the treaty with the country of residence of the actual beneficial owner but in a somewhat circumvoluted manner. On the bright side, the Supreme Court for the first time unambiguously determined that where (a) the apparent recipient of the payment is not the beneficial owner thereof, and (b) [at the same time] the identity of the actual beneficial owner is clearly established, then the relief provided for under the treaty with the country of residence of the actual beneficial owner may be claimed and should apply instead of the relief claimed under the treaty with the country of the apparent recipient of the income. Consequently, the Supreme Court struck down the withholding tax imposed and referred the case back to the same Court of Appeals to examine whether or not the New Zealand entity is the actual beneficial owner of the payments.
The adoption of this approach by the Supreme Court was not self-evident. The treaty with New Zealand, in line with most other treaties, deals with income “paid to”, and the royalties in question were not “paid to” the New Zealand ultimate beneficial owner. The Court concurred in fine with the recommendations of the Advocate General who advised in her conclusions to follow in the steps of other countries such as Italy and the United States, avoid a purely legalistic interpretation of the words “paid to”, and consecrate instead an economic interpretation. In adopting the recommendations of the Advocate General, the Court appears to have relied on the object and purpose of the tax treaty and on the OECD Commentaries. With respect to the first point, the object and purpose of a tax treaty is the elimination of double taxation but also the prevention of tax avoidance and evasion. It seems here that the Supreme Court prioritized the elimination of double taxation objective over the prevention of tax evasion and avoidance objective. On the second point, the Supreme Court relied on the OECD Commentaries up to and including the 2017 updates even though the France-New Zealand treaty predates the invoked Commentaries. Evidently, the Supreme Court ruling is not restricted to royalties; it equally applies to dividends and interest payments which are typically similarly covered by the beneficial ownership condition under tax treaties.
Whilst the Planet ruling settles the issue of treaty relief entitlement in cases involving an apparent recipient and an actual beneficial owner resident in two different treaty partner states, it leaves several issues unanswered.
Firstly, it does not clarify whether the tax authorities have an obligation, when denying the benefits of the treaty claimed by the taxpayer, to spontaneously identify the actual beneficial owner and apply the treaty with the country of that beneficial owner. The Advocate General did clarify in her conclusions that there is no such obligation for the tax authorities, and that it is up to the taxpayer to evidence the identity of the beneficial owner and claim the application of another treaty if it so wishes. However, the Supreme Court did not explicitly adopt this part of the conclusions and instead referred the case back to the Court of Appeals to determine whether the New Zealand entity is the beneficial owner. The more likely outcome is that there would be no such obligation for the tax authorities; it would instead be the responsibility (and choice) of the taxpayer to identify the actual beneficial owner and claim third country treaty benefits accordingly.
Secondly, the Supreme Court does not clarify whether the third country tax treaty claimed by the taxpayer (or spontaneously identified by the tax authorities) applies in its entirety or only with respect to its withholding tax rate clauses. This is important because other clauses of the claimed third country treaty may impact the outcome. For example, let’s assume that the France-Country A treaty provides for a 5% withholding rate with respect to royalties but adopts a broad definition of royalties including service fees. Let’s assume further that the payment to the Country A recipient is in the nature of service fees and that the 5% rate is denied by the tax authorities for lack of beneficial ownership. Let’s assume in addition that the taxpayer identifies the actual beneficial owner as a resident of Country B and claims the application of the treaty between France and Country B. Let’s assume finally that the France-Country B treaty provides for a 15% royalty withholding tax rate but adopts a standard definition of royalties whereby service fees are not classified as royalties and are not subject to withholding tax. Can the taxpayer then claim full relief from withholding tax based on the France-Country B treaty definition of royalties? The answer seems to be yes, evidently. Indeed, one swaps a treaty for another treaty, and not selective portions of a treaty for selective portions of another treaty. This has also been implicitly confirmed by the Court of Appeals in this case when it determined that the payments qualify as royalties under the substituted France-New Zealand tax treaty. Nevertheless, doubts may linger until the issue is formally clarified.
Thirdly and lastly, in referring to and relying on the OECD Commentaries in their versions post the France-New Zealand treaty, the Supreme Court added more uncertainty as to its principled posture with respect to the dynamic vs. static interpretation of tax treaties. This is a matter that deserves a separate analysis but suffice it to say for these purposes that until recently the position of the Supreme Court was pretty much clear cut. Indeed, in its famed 30 December 2003 Andritz decision, the Supreme Court clearly ruled out the use of the Commentary on Art. 9(1) of the OECD Model Convention to interpret the provisions of the France-Austria tax treaty, given that the adoption of the treaty predates the Commentaries referred to. The Supreme Court’s 11 December 2020 ValueClick ruling amounted to throwing a stone in an otherwise calm pond. In the ValueClick case, the Court determined the existence of an agency PE of the Irish ValueClick in France by relying on the 2003 and 2005 Commentaries in interpreting the provisions of the 1968 France-Ireland tax treaty. Eminent French commentators, including Bruno Gouthière whom I personally consider as one of, if not the ultimate authority on anything French international tax law, refused to see in the reliance on the post-treaty Commentaries a pure and simple reversal of Andritz. Instead, they insisted that the post-treaty Commentaries referred to in ValueClick did not extend the original scope of the relevant treaty provisions, and that the Court merely relied on them as persuasive or comforting elements in its own interpretation of the terms “authority to conclude” contracts as included in the 1968 treaty. That justification, I am afraid, holds but by just a thread in the ValueClick case. I am not sure the thread still holds in the present Planet case.
Footnotes
1The expression «un train peut en cacher un autre» is the (more poetic because French) equivalent of the “2 Tracks” warning posted on US railway tracks. It is also used to mean that things are not always what they appear to be.
