US – France Protocol Enters into Force
US - France Protocol Enters into Force
On December 23, 2009, the United States and France completed the process of ratification of a Protocol (“the New Protocol”) to the income tax treaty (“the Treaty”) between the two countries signed in 1994 (for prior coverage, see Flash International Executive Alert 2009-017, January 27, 2009). The New Protocol is the second protocol to the Treaty; a previous protocol was signed in 2004 and entered into force on December 21, 2006 .
Entry into Force
The provisions of the New Protocol relating to taxes withheld at source are retroactively effective as from January 1, 2009, and the provisions relating to other taxes will generally be effective as from January 1, 2010. Different effective dates apply to certain provisions relating to article 26 (Mutual Agreement Procedure).
Fiscally Transparent Entities
Article I of the New Protocol amends paragraph 2 of article 4 of the Treaty concerning residency. The purpose of these amendments is to clarify that certain specified entities will be treated as residents of either France or the United States, respectively.
The amendments to paragraph 2 of article 4 also address the treatment of cross-border investments made through certain entities.
Under this provision, certain items of income paid from the United States to a French qualified partnership will be treated as derived by a resident of France, but only to the extent that such income is included currently in the taxable income of a shareholder, associate, or other member that is otherwise treated as a resident of France. A French qualified partnership is defined as a partnership that has its place of effective management in France, but has not elected to be taxed as a corporation in France, the tax base of which is computed at the partnership level for French tax purposes, and all of the shareholders, associates, or other members of which are liable to tax in France on the profits of the partnership under French tax law.
Article I of the New Protocol also adds a new paragraph 3 to article 4 of the Treaty (the Residency article). Under this provision, an item of income, profit ,or gain derived through an entity that is treated as fiscally transparent under the domestic laws of either contracting state (France or the United States) is treated as derived by a resident of a contracting state to the extent that such income is treated as the income of a resident under the domestic law of either contracting state, provided the following conditions are met:
(1) the fiscally transparent entity is formed or organized in either contracting state; or
(2) it is formed or organized in a third country that has concluded a tax treaty or other agreement that contains an exchange of information provision with the contracting state from which the income is derived.
Thus, for example, if a corporation resident in France distributes a dividend to an entity formed or organized in the United States, and treated as fiscally transparent for U.S. tax purposes (e.g., a partnership), the dividend will be treated as derived by a resident of the United States (and therefore eligible for treaty benefits) only to the extent that U.S. tax laws treat one or more U.S. resident partners (whose residency status is determined for this purpose under U.S. domestic rules) as having derived dividend income for U.S. tax purposes. Persons whom the United States treats as partners but who are not U.S. residents for U.S. tax purposes may not claim benefits under the Treaty in relation to the dividend. If, however, such persons are residents of a third country that has a treaty with France, they may be entitled to benefits under that treaty.
Paragraph 3 of article 4 is not excepted from the scope of the saving clause in article 29 of the Treaty. Hence, for example, if a U.S. LLC, with members who are resident of France, elects to be taxed as a corporation for U.S. tax purposes, the United States will tax the LLC on its worldwide income, without regard to whether France views the LLC as fiscally transparent for purposes of its domestic tax laws.
Royalties
Article III of the New Protocol amends article 12 of the Treaty (Royalties) so as to provide that all kinds of royalty income, as defined in the Treaty, are subject to tax only in the country of residence of the beneficial owner of the income. Prior to this amendment, the Treaty provided that the source country was permitted to tax royalty income at a maximum rate of 5 percent.
However, under the New Protocol, as under the Treaty, the exemption from source country taxation is not applicable if the beneficial owner of the income carries on business in the country where the royalties arise through a permanent establishment, or performs independent personal services from a fixed base in that country, and the royalties are attributable to such permanent establishment or fixed base. In such case, article 7 (Business Profits) or article 14 (Independent Personal Services) will apply.
Social Security and Pension Income
Paragraph 1 of article 18 of the Treaty (Pensions) provides that payments made under the social security or similar legislation of one country to a resident of the other country are taxable only in the first-mentioned country, i.e., the source country. A similar rule applies for pension distributions and other similar remuneration paid from a pension fund or other retirement arrangement established in one country to a resident of the other country, whether as a lump sum or periodic payments; such payments are subject to tax only in the source country.
KPMG Note
This rule of exclusive source-country taxation differs from the U.S. Model Treaty and from the majority of income tax treaties to which the United States is a party; such treaties generally provide for exclusive taxation by the country of residence of the recipient of the income.
Paragraph 1 of article 18 of the Treaty is excepted from the scope of the saving clause in article 29 with the result that a U.S. citizen living in the United States and receiving French social security benefits or distributions from a French pension plan is subject to tax only in France on such income.
Article VI of the New Protocol revises paragraph 1 of article 18 of the Treaty to clarify that France has the exclusive right to tax payments under its social security or similar legislation that are made to a U.S. citizen who is a resident of France.
Saving Clause
Paragraph 2 of article 29 of the Treaty (Miscellaneous Provisions) contains the saving clause, which reserves the right of each country to tax its citizens and residents (as determined under the residency provisions of the Treaty) as if the Treaty had not come into effect.
The New Protocol amends the terms of the saving clause to reserve the right of the United States to tax its former citizens and former long-term residents for a period of 10 years following such individuals’ loss of such status under the U.S. expatriation tax rules. Prior to this amendment, the Treaty reserved this right only in respect of such individuals whose loss of such status had a principal purpose of tax avoidance. The New Protocol removes the requirement that such individuals have a principal purpose of tax avoidance, thus bringing the wording of the saving clause into conformity with the current wording of section 877 of the U.S. Internal Revenue Code, which applies to certain individuals who relinquished their U.S. citizenship or terminated their U.S. residency prior to June 18, 2008.
The New Protocol also amends the saving clause so as to reserve France’s right to tax entities that have their effective place of management in France and that are subject to tax in France, as if the provisions of paragraph 3 of article 4 relating to fiscally transparent entities (described above) had not come into effect.
Public Remuneration
The New Protocol amends the rules applicable to certain French government employees, by adding a new paragraph 9 to article 29 of the Treaty (Miscellaneous Provisions) and deleting paragraph 2(c) of article 24 (Relief from Double Taxation).
Paragraph 9 of article 29 provides that remuneration other than a pension paid by France, or by a local authority or agency or instrumentality of France (i.e., the French government), to an individual for services rendered to the French government is taxable only in the United States if the services are rendered in the United States and the individual is a resident and national of the United States, or a U.S. greencard holder.
KPMG Note
The purpose of this amendment is to remedy certain situations where double taxation could arise under the Treaty prior to this amendment.
Source: KPMG
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