Luxembourg and France have been very closely linked for centuries. So, it’s only natural that the French market is crucial for Luxembourg banks and insurance companies in terms of local sales activities.
As wealth planning solutions in particular require a close presence to clients, most Luxembourg banks and insurance companies sell their services on French territory. This is often done, however, without having local premises, but rather through the occasional presence of the Luxembourg financial actor’s employees.
With the new French-Luxembourg double tax treaty which entered into force on 1 January 2020, the risk for a Luxembourg bank or insurance company having a taxable permanent establishment (PE) in France has increased significantly.
The treaty has modified the conditions for the recognition of a PE by the respective tax authorities. Its new approach is now more aligned with economic reality. At the same time, however, it is stricter and therefore must not be overlooked by taxpayers.
What if you fail to declare a PE? You can expect to face potentially significant and burdensome consequences including arbitrary tax assessments, transfer pricing re-adjustments and even criminal sanctions.
A shift in approach: from formal to economic
The previous double tax treaty (between France and Luxembourg in 1958) laid out the conditions for a PE in its Article 2.3. It applied a fairly formalistic approach, relying to a large extent on circumstances such as the place of signing the relevant contracts.
Today’s treaty is heavily influenced by the OECD’s Base Erosion and Profit Shifting (BEPS) project, and especially by Action 7. Based on this new approach, the analysis of whether a PE exists should have a primarily economic aspect as the overly formalistic features of the past made it too easy for taxpayers to bend the rules to their benefit.
The clearest example is the new, wider scope of the notion of a “dependent agent”, which can give rise to a PE. A Luxembourg company is now considered to have a “dependent agent” in France if a person acts in France on behalf of that company and, in doing so, enters into contracts or takes the lead in the conclusion of contracts which are:
- routinely entered into without significant modification by the company
- in the name of the company or for the provision of services by that company
The mere formal act of signing a contract in one country is now very unlikely to outweigh the fact that the negotiations leading up to it took place in the other country. If the essential contents of a contract were agreed upon in the other country, a PE is very likely.
On top of these changes, the new treaty also introduced more details on how preparatory and auxiliary activities should be interpreted. The anti-fragmentation rule should make it more difficult for closely related parties to artificially split these activities as a means of avoiding the outcome of a PE.
Impact on Luxembourg private banks
It is part of the business activity of Luxembourg private banks to engage with clients in bordering jurisdictions, including France. Financial institutions based in Luxembourg have relied on this proximity to France for decades due to the size of the Grand Duchy.
Numerous Luxembourg banks actively and consistently seek out customers in France. They regularly send their employees to France where they meet clients and work towards negotiating and concluding new contracts. In some situations, the employees themselves are authorized to sign the final contracts.
In light of the new treaty’s framework, the power to sign contracts is no longer the central criterion for a PE. The new treaty looks to a much larger degree at the bank’s value chain, i.e. at whether a major part of the contract conclusion process takes place in the country in question.
This means that the new treaty’s conditions for a PE could more often be met by Luxembourg private banks.
State of play in the Luxembourg insurance sector
Insurance companies could just as suddenly find themselves within the scope of the new rules. Just as banks do, they rely on foreign clients for the long-term stability of their business, so their employees hold similar client acquisition meetings abroad. Luxembourg’s standing as a hub for life insurance contracts is yet another reason for building up and maintaining a foreign client base.
Moreover, it is almost a standard approach for insurance companies to market and sell their products across the EU. The Europe-wide free distribution of services has been given a remarkable boost by the EU’s 2016 Insurance Distribution Directive. Against this backdrop, the incentives for European insurance companies to deploy their employees abroad are now even more obvious.
Admittedly, mere marketing or presentation of a Luxembourg company’s products without a link to a specific contract might be unlikely to give rise to a PE in France. The widened scope of the notion of a “dependent agent”, however, along with a multi-tiered analysis of various circumstances of each case, make it more difficult to predict how the tax authorities will view a particular set of facts.
All in all, an insurance company’s foreign activities might be treated as bearing the characteristics of a PE sooner than expected and, in turn, quickly lead to action by the tax authorities.
Given the inherent risks, it is crucial to structure the activities of the employees beforehand or analyze the structure already in place. The aim is to minimize the exposure of these activities to the scope of the treaty’s notion of a PE.
From a broader perspective, the discernible influence of BEPS Actions 7 and 15 on the new treaty might be a telling sign that France and Luxembourg are trailblazers rather than outliers on the issue of PE, with other countries soon following suit.
More questions about PE risks and solutions? Get in touch with our Financial Services Tax team!