On 3 May 2007, the Luxembourg Administrative Court gave its decision in case No. 22499 C on the taxability of income from real estate derived by a Luxembourg public limited company from real estate held in France through a French partnership, which did not opt to be taxed as a corporate entity in France. Details of the decision are summarized below.
(a) Facts. A Luxembourg public limited company (société anonyme, SA)owned all the shares of a French real estate partnership (société civile immobilière, SCI). In 2003 and 2004, the SCI earned rental income from French real estate and realized capital gains on the sale of French real estate. The Luxembourg tax administration assessed the Luxembourg SA on income and gains received by the SA through the French SCI for tax assessment years 2002 and 2003. The taxpayer rejected the assessment and brought the case to Court.
(b) Legal background. Art. 3 of the France-Luxembourg tax treaty on income and capital of 1958 (the Treaty) provides that income derived from real estate and profits derived from the alienation of such property are taxable in the state in which the property is situated.
Art. 19(2) of the Treaty provides that, notwithstanding the provisions of the Treaty, each of the two contracting states retains the right to tax in accordance with its statutory regulations, earnings from participations in enterprises constituted as a private company (société civile), partnership (société en nom collectif), de facto partnership (société de fait), special partnership (association en participation) as well as earnings by general partners from their participation in general partnerships (société en commandite simple). Under Art. 19(2)(a), Luxembourg shall grant a credit against the tax payable on earnings derived from the participation in the French SCI.
(c) Issue. The issue was whether or not the Luxembourg tax administration was authorized under the Treaty to tax the income and the capital gains derived by a Luxembourg SA from its participation in a French SCI.
(d) Decision of the Luxembourg Administrative Tribunal. The Luxembourg Administrative Tribunal in its decision of 20 December 2006 first determined whether the French SCI should be treated as a transparent or non-transparent entity for Luxembourg tax purposes. From a comparison of the legal characteristics of the SCI with the Luxembourg société civile and a Luxembourg capital company, the Tribunal deduced that the SCI is comparable to a Luxembourg société civile, which is a transparent entity. Therefore, the Tribunal held that the rental income and capital gains derived by the SCI had to be attributed to the Luxembourg SA.
In addition, the Tribunal noted that earnings from participations only cover current real estate income and not capital gains from the sale of real estate.
The Tribunal referred to Art. 3 of the Treaty under which income derived by a Luxembourg company from French real estate may only be taxed in France. The Tribunal decided that Art. 19(2) of the Treaty, which allows both States to tax income from participations in a société civile in accordance with its statutory regulations, was not applicable in the case at hand. According to the Tribunal, Art. 19(2) would only be applicable if Luxembourg had the right to tax the underlying income of the French SCI pursuant to other Treaty articles. Consequently, the Tribunal decided that income from French real estate derived by the Luxembourg SA through the French SCI fell within the scope of Art. 3 of the Treaty and was therefore not taxable in Luxembourg.
(e) Decision of the Administrative Court. The Administrative Court partially overturned the decision of the Administrative Tribunal.
The Court first upheld the position of the Tribunal under which the definition of earnings from participations as set out in Art. 19(2) excludes capital gains, and merely covers current income. Further, the Court observed that Art. 19(2) of the Treaty authorizes each treaty state to tax earnings from a participation in a société civile in accordance with its domestic laws and provides the method to avoid double taxation. The Court held that by not applying this provision the Tribunal misinterpreted the Treaty.
The Court then overturned the position of the Tribunal under which Art. 19(2) could only be applied insofar as Luxembourg had the right to tax the underlying income of the French SCI under other Treaty provisions. The Court considered that the simple presence of the French SCI is sufficient to apply Art. 19(2) of the Treaty, which excludes the application of any other Treaty provisions. In addition, the Court held that for the application of Art. 19(2) of the Treaty it is irrelevant to whether the French SCI is taxed as a transparent or non-transparent entity.
Therefore, the Court then decided that the current income from real estate derived by the Luxembourg SA from real estate owned by a French SCI is subject to Luxembourg corporate income tax pursuant to Art. 19(2) of the Treaty. On the other hand, the Court implicitly confirmed the decision of the Tribunal under which the capital gains derived by the SA from the sale of French real estate by the French SCI were taxable in France pursuant to the application of Art. 3 of the Treaty.