On August 31, 1994, France and the United States signed a new treaty intended to replace the treaty signed in 1967; it contains certain original solutions which will have an indisputable effect on transatlantic investment.

1. The Good News

Though not all are spectacular, certain provisions will facilitate exchanges between the two countries. First, the concept of residence, defining the beneficiaries of the treaty, is now connected with the concept of liability to tax, absent from the current treaty but the cornerstone of the OECD model treaty. Certain entities, most of which had been previously ignored by tax treaties, are also treated as resident though exempt from or not liable to tax: retirement funds, non-profit entities and undertakings for collective investment. This last class includes French unincorporated mutual funds (fonds communs de placement), so that they have achieved the desirable status of tax residents even though they are not legal entities under French law. The tax personality of undertakings for collective investment in international relations had been accepted in practice, especially on the French side, but official recognition by the USA provides desirable additional safety for financial transactions.

Further good news, concerning royalties: the new treaty extends the exemption from withholding tax, applicable in the past only to copyright royalties, to royalties for cinema films, recordings of sound or pictures, and software. This last point is especially welcome since the exemption applied in the past only to the royalties paid to designers of software and not to those collected by parties having acquired it or obtained licenses. Henceforth, any royalty relating to software will be exempt from withholding tax.

On the US side, the treaty confirms the partial refund of imputation tax credits (avoir fiscal) to US pension funds granted unilaterally by the French tax authorities in September 1993, and has extended it to pension funds managed by the government and other US public authorities, non-profit entities and individual pension schemes. Last, US citizens resident in France, who had been granted an exemption from French taxes in respect of certain forms of US-source investment income, will retain that benefit, even though the exemption has been replaced by a tax credit equal to the French tax payable on such income.

2. A Tighter Governmental Grip?

The most striking provision of the new treaty is article 30, which limits the benefits of the treaty. The purpose of this article is to deny the benefit of the treaty to entities, other than individuals, which are resident in one of the countries solely in order to use the treaty. Article 30 accordingly sets out various criteria (identity of shareholders, amount of taxable base, reality of business,...) to identify entities such as relay-companies. This complex provision may be useless in practice, as this kind of company is almost non-existent in France; but it will nonetheless create cumbersome reporting obligations for French companies when they seek to prove that they are indeed eligible for the benefit of the treaty.

The two tax departments have also decided to reinforce their administrative cooperation, by specifying certain details of the procedure for information exchanges: the agents of one state will now be able to visit the other for the purposes of tax audits in order to obtain information from the taxpayers direct. The treaty provides, however, that such inspections shall require express prior consent from the taxpayer.

3. Encouraging signs for the future

The article of this treaty providing a solution for unforeseen cases of double taxation contains two novelties of particular interest.

It provides first for an arbitration procedure, which ought to ensure that the competent authorities will reach a solution: the currently-applicable treaty states only that the competent authorities shall "seek to resolve their differences. The arbitration procedure will allow problems to be settled finally, provided that all the parties concerned agree to abide by the decision. This is particularly welcome with respect to the new transfer-pricing legislation in the USA, which is not always consistent with French principles. In addition, this arbitration procedure will supplement that provided for under the European treaties, due to become effective on January 1, 1995.

The other novelty consists of a provision that difficulties may be resolved by the competent authorities for future years as well as past years. This mention of future years refers to a procedure set up by the US tax authorities, the "Advance Pricing Agreement", consisting of an agreement between a US tax taxpayer and the authorities as to the transfer prices applied by such taxpayer for coming years. The French tax authorities have always been reluctant to make this kind of agreement for the transfer prices applied for a US group by the French subsidiary of that group (event though the treatment of headquarters is an extensively-used application of this principle), emphasizing that French tax legislation did not allow them to enter into such agreements. The new tax treaty would therefore constitute a statutory basis for execution of a bilateral Advance Pricing Agreement binding on the taxpayer and the French and US tax services.

The new treaty will become effective after ratification by the US Senate and the French Parliament. As it is not yet the case, this would mean that most of the provisions of the new treaty would be in force, at best, only from January 1, 1996.

For further information contact Robert Tarika (Paris) (33) (1) 46 93 67 83, or Stephane Gelin (New York) (1) (212) 773 6330.
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