Treatment of Partnerships in the 2008 France-U.K. Tax Treaty by Nicolas De Boynes and Andrew Howard

Volume 54, Number 5 May 4, 2009 C a nlss20.Alrgt eevd a nlssde o li oyih naypbi oano hr at content. party third or domain public any in copyright claim not does Analysts Tax reserved. rights All 2009. Analysts Tax (C)

Treatment of Partnerships in the 2008 France-U.K. Tax Treaty by Nicolas de Boynes and Andrew Howard

Nicolas de Boynes is an associate with Sullivan & Cromwell LLP in Paris, and Andrew Howard is an associate with Sullivan & Cromwell LLP in London.

t has traditionally been left to domestic courts to I. Domestic Approaches to Partnerships Imake sense of the various difficulties that arise in applying double tax agreements to partnerships (in the A. U.K. Domestic Treatment U.K., see Padmore1 and Memec;2 in France, see Kin- Put briefly, the U.K. corporation tax rules provide group3 and Diebold4). It is therefore interesting to see an for the profits of a partnership to be calculated at the attempt at an exhaustive code for the treatment of partnership level and assessed on each partner in ac- partnerships included in the long-negotiated new cordance with its partnership share as if the profits double tax treaty (DTT) between the U.K. and France, were earned directly by it. A non-U.K.-resident corpo- expected to be ratified shortly,5 replacing 2004’s abor- rate partner will therefore not be subject to U.K. corpo- tive agreement. ration tax on profits derived through a U.K. partnership unless it is trading in the U.K. through a Partnerships are a particular area of difficulty be- permanent establishment there. tween the U.K. and France as France does not yet sub- scribe to the ill-defined principle that partnerships are This treatment applies to all forms of U.K. partnership, including limited liability partnerships. Non-U.K. transparent for tax purposes, whereas the U.K. does. partnerships will be treated in the same way if they In this article we look at how some of the difficul- have similar characteristics to U.K. partnerships. HM ties have been addressed and others created. In particu- Revenue & Customs guidance says that it will ‘‘look at lar, a change is made to the general rules on treaty ex- the foreign commercial law under which the entity is emption from U.K. withholding tax to shut an formed and at the internal constitution of the entity. apparent loophole. Some possibilities of double taxa- How the entity is classified for tax purposes in any tion are resolved, but some difficulties remain. other country is not relevant.’’6 HMRC has published a list of entities that it has considered.7 The list indicates whether a particular entity has been considered to be ‘‘transparent’’ or 1Padmore v. IRC, [1987] STC 36. 2Memec Plc v. IRC, [1998] STC 754. 3CE, Apr. 4, 1997, no. 144211, RJF 5/97, no. 424. 4CE, Oct. 13, 1999, no. 191191, Dr. fisc. 1999, no. 52, comm. 6HM Revenue & Customs International Manual at INTM 948. 180010. 5The U.K. ratified the DTT on February 11, 2009. 7INTM 180030.

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‘‘opaque.’’ The Groupement d’Intérêt Economique, the So- expressed in the French reservations on article 4 of the (C) Tax Analysts 2009. All rights reserved. does not claim copyright in any public domain or third party content. ciété en Nom Collectif, the Société en commandite simple, the OECD model convention:10 Based on the French do- Société en participation, and the Fonds Commun de Place- mestic tax law, a French partnership is viewed as liable ment à Risques have been considered to be transparent. to tax and is resident for tax treaty purposes. Most re- These are the main types of French entities that are cent tax treaties entered into by France specifically pro- referred to as partnerships in this article. vide that French partnerships are treated as residents.11 B. French Domestic Treatment 2. Foreign Partnerships and Transparency The French treatment of foreign partnerships has 1. ‘Translucent’ Approach to French Partnerships been recently reformed according to an important deci- The French approach to partnerships is based on the sion by the French Supreme Court (Diebold), which same principle as that applicable in the U.K.: The was later extended by official guidelines published by profits of the partnership are calculated at the partner- the French tax administration.12 While the traditional ship level and effectively taxed in the hands of the approach was that foreign partnerships are taxable enti- partners. However, France draws from there a conclu- ties by analogy to the treatment of French partner- sion that differs from the position of most OECD ships, the principle set by the guidelines is that regard- countries (including the U.K.). It considers that ‘‘the ing French-source income payable to a non-French fact that the partnership is a legal person precludes the partnership, non-French partnerships are transparent view that income simply ‘flows through’ this entity to for the purposes of applying DTTs, if the entities are the partners.’’8 Instead of treating the partners as if viewed as transparent for tax purposes in their state of they had received the profits directly, the French point residence. For example, French-source income may of view is that the partnership is the ‘‘taxable entity’’ benefit from reduced withholding tax rates under the even though the collection of the tax is at the level of applicable tax treaty signed between France and the the partners. Partnerships are thus viewed as ‘‘semi- state of residence of the partners under some condi- transparent’’ or ‘‘translucent.’’ tions. The scope of the guidelines is limited to divi- A non-French resident partner in a French partner- dends, interest, and royalties. ship will be subject to tax in France even if the French However, the traditional concept of ‘‘translucency’’ is partnership is not engaged in a trade or business in still used regarding inbound income received by French France. The rationale is that any item of income received partners through non-French partnerships. While the by a French partnership (including passive income) is French individual partners should be subject to tax in taxable in France because the partnership is a taxable France on their share of the partnership’s income (just entity. The collection of the tax is made at the level of like under a transparency regime), French corporate the partners (including nonresident partners). Even partners will not be taxable on that income on applica- though the tax is collected in the hands of the partners, tion of the French territoriality system because the in- the French Supreme Court (Conseil d’Etat) has ruled come is viewed as the income of a foreign partnership that tax treaties do not protect the nonresident partners (out of the scope of the French corporate income tax) against such taxation because the ‘‘taxable entity’’ is the and not the income of the French corporate partner. Sub- partnership (not the partners). While the partners do not sequent distribution by non-French partnerships will not have a PE in France, the fact that the assets generating be taxable income in the hands of the partners. passive income are held by a French partnership has al- The criteria under French law to determine the most the same consequence as reporting these assets in a question whether a non-French entity will be viewed as French PE of the partner (Kingroup). a partnership or as a corporation are not clearly settled. This approach also has an impact on whether the However, it is generally accepted that non-French enti- partnership should be viewed as ‘‘resident’’ according ties that have legal characteristics similar to French to DTTs. Under the widespread OECD approach, partnerships are subject to the translucent regime. The which is shared by the U.K., partnerships are not resi- main characteristic used to distinguish between a part- dent for purposes of the DTTs, but their partners nership and a corporation is the liability of the should be entitled to benefit from the treaties, pro rata partners/shareholders: Unlimited liability would indi- to their partnership share, in the state in which they cate a partnership, while a limited liability would indi- are resident.9 In contrast, the French tax administration cate a corporation. The tax treatment applicable in the has historically taken a position that is unique among state of residence is not relevant. One result is that an OECD countries, under which French partnerships English LLP would be viewed as opaque entity under must be treated as French residents. This position is French tax law.

10 8Reservations by France on the report on ‘‘The Application OECD Commentaries, C(4) no. 29. of the OECD Model Tax to Partnerships,’’ no. 12. 11For instance, article 4.6 of the France-Japan tax treaty. 9OECD Commentaries, C(1) no. 5. 12Inst. 29-3-2007, 4 H-5-07.

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If the foreign partnership is viewed as a corporation III. Article 4.5 of the DTT (C) Tax Analysts 2009. All rights reserved. does not claim copyright in any public domain or third party content. for French tax purposes, no tax will be due in France Article 4.5 makes specific provision for the applica- when the partnership receives the income, but any dis- tion of the DTT to six situations involving partner- tribution by the partnership to its French partners ships.16 We have grouped these into three categories: would be taxable in France as dividend income. when the source state and the state in which the partnership is established are different; when the source II. Partnerships Under the DTT state and the state of establishment are the same; and France has not accepted recognition of the full when third country partnerships are involved. The sec- transparency of partnerships as a general principle.13 ond and third categories are most problematic. Instead, the U.K. respected the French translucency approach, and several specific solutions in the new Article 4.5 makes DTT are supposed to deal with the adverse tax conse- quences of this approach. specific provision for the Unlike the existing treaty, the new DTT contains application of the DTT to extensive provisions dealing with partnerships. As well as article 4.5, discussed in detail below, specific provi- six situations involving sion is made for some French partnerships to be partnerships. treated as resident for purposes of the DTT,14 and provision is also made for the situations in which a partnership will constitute a PE of its partners.15 Article 4.5 of the DTT follows the examples and the Under the existing treaty, the tax residency of a solutions provided in the OECD report17 on partner- partnership is not specifically dealt with. France’s reser- ships.18 While the report generally recognizes the com- vation on the commentary to article 4 of the OECD plexity of the different ways partnerships are treated in model convention referred to above provides that different states,19 these examples tend to be based on ‘‘France reserves the right to amend [article 4 of the the transparent vs. opaque dichotomy and do not al- OECD model] in its tax conventions in order to specify ways apply comfortably in the context of the French that French partnerships must be considered as resi- translucent approach. The solutions applicable to dents of France.’’ However, notwithstanding the ab- opaque entities in the OECD report are transposed in sence of that amendment, France interprets the exist- the DTT to translucent partnerships, and this appears ing treaty on the basis that a French partnership is to be the reason for some of the difficulties discussed resident because it is liable to tax in France. The U.K. in the scenarios below. takes the opposite view (unless the French partnership The provisions are drafted so that they may have is treated as opaque because it does not have the char- equal application in the case of each contracting state, acteristics of a U.K. partnership). Some of the issues but under current law the practical application of each that this creates are discussed below. of the scenarios is one-sided: The state treating income derived through a partnership as ‘‘the income of that partnership’’ is France, while the state treating the in-

13 come as ‘‘the income of the partners’’ is the U.K. (at A full transparency regime would have implied that some least when the relevant entity is considered to be trans- French residents that are not taxable under current domestic 20 rules would become taxable under the DTT, while other resi- parent). dents that are taxable under domestic rules would have been ex- empted under the DTT. Because it is generally believed that a tax treaty cannot impose taxation that is not provided for in the domestic tax rules, such a conceptual jump would have first re- 16The first three situations are inspired by the provisions of quired a change of French domestic rules. For instance, as indi- the recent tax treaty signed by France and Japan, which itself is cated above, French-source income received by a U.K. partner inspired by the provisions of the tax treaty signed by Japan and through a French partnership is not subject to withholding tax the U.S. under French domestic tax law, but the U.K. partner is subject to 17 income tax in France. Assuming France had generally recog- Report of the OECD Committee on Fiscal Affairs on the nized the full transparency of French partnerships in the DTT, Application of the OECD Model Tax Convention to Partner- the DTT would have switched the level of taxation by providing ships, 1999. that the income would be subject to withholding tax (under the 18For a comparison of the OECD report on partnerships and conditions provided for in the DTT) but would not be subject to the DTT, see J.A. Jones, ‘‘The New U.K.-France Tax Treaty,’’ French income tax in the hands of the partner. However, since Bulletin for International Taxation, Oct. 2008, p. 457. French domestic law does not provide for such withholding tax, 19See Annex III of the OECD report. the French-source income would be totally exempt in France. 20 14 One could question whether France could be considered as Article 4.4 of the DTT. the state treating ‘‘the income derived from a partnership as the 15Paragraph 3 of the protocol to the DTT. income of the beneficiaries.’’ Our view, as set out above, is that (Footnote continued on next page.)

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This drafting was apparently used for two reasons. (C) Tax Analysts 2009. All rights reserved. does not claim copyright in any public domain or third party content. First, the discussions on this article occurred partly in Figure 1. Article 4.5(a) 2006 and 2007, at a time when the French regulations confirming the tax transparency of foreign partnerships under Diebold regarding outbound income had not been issued. This article thus had to address the situation in U.K. partner which the partnerships would be viewed as translucent for French tax purposes. Second, the French tax administration contemplates a more global reform that would recognize the transparency of French and foreign partnerships (and not only the transparency of foreign partnerships regarding outbound income). The drafting was therefore designed to be adaptable to this expected reform: Article 4.5 would no longer be gener- U.K. ally applicable to French partnerships and would apply only when a conflict of characterization (transparent partnership vs. opaque) arises between the French and U.K. analy- ses. U.K. Article 4.5 works off the concept of where a partnership is established. This could also lead to uncer- France tainty of application as the U.K. is likely to take the view that a partnership is established in the state under French-source income whose law it is organized, whereas France may regard a partnership as being established in a different state if its place of effective management is located in that The article would have had a practical effect when state. In this article, it is assumed that both states agree France is the source state before the reform of the on the place of establishment of the partnership. treatment of foreign partnerships under Diebold: Before A. Different Source and Establishment States this case, France would not have recognized that the 1. Article 4.5(a) — The New DTT U.K. partner had an entitlement to the benefits of the DTT because the U.K. partnership was viewed as Article 4.5(a) addresses the case when the source translucent. state (France) does not recognize the transparency of the partnership,21 but the residence state of the partner Under the principles set forth in Diebold and the (the U.K.) does recognize the transparency. (See Figure 2007 guidelines, France now recognizes the transpar- 1.) In this case, the income will nonetheless benefit ency of foreign entities, and article 4.5(a) will not have from the DTT as if it were received directly by the any practical effect in this situation. This article was partners, if the partnership is viewed as transparent in discussed between both tax administrations before the the U.K. French tax authorities issued official guidelines in This article will not be applicable when the source March 2007 that recognized the principles set forth by state is the U.K. Diebold. Also, this provision protects the U.K. against a change in French case law on this matter, because if ever the French courts were to reverse Diebold, the DTT would prevail on this point. it could not. This position has been confirmed by the French administration in official guidelines on the treatment of partner- The case in which the partner is a French resident is ships in the context of the France-U.S. tax treaty (Inst. 6-5-1999, not addressed by the DTT. However, under the 2007 14 B-3-99): ‘‘Under French domestic law, the taxable person is guidelines, no withholding tax would be applicable to the partnership itself, even if the collection of taxes is not made the French-source income. in the name of the partnership but in the name of the partners. Indeed, the entity that realizes the income is the partnership, not 2. Article 4.5(a) — The Existing Treaty the partners.’’ In the Kingroup case, the French Supreme Court confirmed that the income received by a French partnership with The position is the same under the existing treaty Canadian partners could not be viewed as the income of the following Diebold and the guidelines issued by the partners and therefore could not benefit from the protection of French tax administration, although the scope of the the Canada-France tax treaty. The advocate general in this case guidelines is limited to dividends, interest, and royal- clearly states that the application of the treaty ‘‘would contradict ties. the regime of the partnership since it would imply that the partnership is fully transparent and that the royalties received by the 3. Article 4.5(b) — The New DTT partnership are viewed as income of the partners.’’ 21This article corresponds to example 4 of the OECD report Article 4.5(b) deals with the case in which the state on partnerships, supra note 17. of establishment of the partnership (France) does not

404 • MAY 4, 2009 TAX NOTES INTERNATIONAL PRACTITIONERS’ CORNER treat the income as received by the partners,22 and the Direct Tax on the Partners’ Share of Income — Taxation of (C) Tax Analysts 2009. All rights reserved. does not claim copyright in any public domain or third party content. partnership receives income from the other state (the U.K. Partners in the U.K. It might be thought that the U.K.). (See Figure 2.) That income will benefit from U.K. was prevented from taxing a U.K. resident part- the DTT if the partnership is resident under the DTT. ner on the basis that the income should be regarded as profits of the partnership, which is an enterprise of France, making the profits taxable only in France under the Business Profits Article. However, following Figure 2. Article 4.5(b) Padmore, in which the court felt bound to apply this analysis, U.K. domestic tax law24 was modified, and French, U.K., paragraph 5 of the protocol to the DTT confirms that or third- the U.K. retains taxing rights. The U.K. will exercise country these rights, although it would give credit for French partner tax on the basis that paragraph 5 of the protocol deems the income to have a French rather than a U.K. source. 4. Article 4.5(b) — The Existing Treaty Withholding Tax on U.K.-Source Income. Exemption from U.K. withholding tax (or a reduced rate) could be French claimed by the partners if a domestic or treaty partnership exemption/reduced rate would have been available to them had they owned the income directly, under a tax France treaty between their state of residence and the United Kingdom. An exemption or reduced rate could be U.K. claimed at the partnership level if all the partners are 25 U.K.-source income French resident by HMRC concession, but the partnership itself would not otherwise be entitled to claim exemption/reduced rate. Direct Tax on the Partners’ Share of Income. The position for French tax purposes would be the same as un- Under article 4.4 of the DTT, partnerships that are der the new DTT. In particular, a U.K. partner would effectively managed in France are recognized as resi- be taxable in France according to Kingroup. The U.K. dent in France (transparent partnerships cannot be resi- position would also be the same as under the new dent in the U.K. for treaty purposes). DTT regarding the taxation of U.K. partners. However, Withholding Tax on U.K.-Source Income. In this sce- in the absence of a specific provision making the part- nario, the U.K. will grant a withholding tax nership resident for the purposes of the existing treaty, exemption/reduced rate just like any income received it is not thought that the U.K. would grant relief from by a French resident, by reference to the partnership, the resulting double taxation. notwithstanding the identity of the partners. It is not clear whether France will grant a tax credit equal to any U.K. withholding tax.26 For sure, France Direct Tax on the Partners’ Share of Income — Taxation of will not grant relief for tax imposed by the U.K. on the the Partners in France. According to Kingroup, French as U.K. partners on their share of the partnership income. well as non-French partners are taxable in France on A U.K. partner in this situation may have to apply un- their share in the partnership income, even if the part- der the mutual agreement procedure for a remedy for nership receives only passive income. Even though the its double taxation. DTT is not clear on this point, France should grant a This problem for a U.K. partner is solved under the tax credit equal to any U.K. withholding tax. This will new DTT by the U.K. conceding to the French posi- have to be clarified in the guidelines to be published by tion and giving a tax credit equal to French taxes. the French tax administration. However, if the partnership receives income from a third country, it is not clear whether France will grant 24 a tax credit equal to any tax withheld in the third Section 1266 of the Corporation Tax Act 2009, as supple- 23 mented by the new section 815AZA of the Income and Corpora- country under French domestic law. tion Taxes Act 1988. 25INTM 335510: Whereas normally a separate claim for U.K. treaty relief is made by each partner, in this case the claim would be made by the managing or general partner on behalf of 22This article corresponds to example 5 of the OECD report the partnership and may have to contain additional information on partnerships, supra note 17. such as the partners’ names and addresses. 23CAA Paris, Rinsoz et Ormond, RJF 2/93, no. 262. 26CAA Paris, supra note 23.

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B. State of Source Is State of Establishment dence of the partners ‘‘and should not be limited in its (C) Tax Analysts 2009. All rights reserved. does not claim copyright in any public domain or third party content. taxing rights.’’ Under this view, ‘‘the situation involves 1. Article 4.5(c) — The New DTT a purely domestic matter from the perspective of State Article 4.5(c) addresses the case when the state of P; it is simply taxing the domestic source income of a residence of the partner (the U.K.) views the partner- resident taxpayer and nothing in the Convention can ship as transparent while the state of establishment of limit that right.’’27 the partnership (France) views the partnership as The factual situation is pretty different in the case opaque or translucent. (See Figure 3.) addressed by article 4.5(c) because the French partnership is not opaque but only translucent. The French partnership does not pay itself any tax on its income; Figure 3. Article 4.5(c) the partners do. Because the partners are not French residents, the situation is not purely domestic. While under the example provided in the OECD report the source of the income and the taxpayer were in the U.K. partner same state (which would justify the nonapplication of the tax convention), the scenario of article 4.5(c) U.K. clearly involves a cross-border situation in which a state taxes a foreign resident. Therefore, one may ques- France tion whether the line of reasoning proposed by example 17 of the OECD report should have been fol- lowed in the DTT. French 2. Article 4.5(c) — The Existing Treaty partnership A U.K. partner would be taxable on its French- source income both in France under Kingroup principles and in the U.K. under domestic law. It is not clear how double taxation would be elimi- nated. The French source indicates that the U.K. should give credit, but the U.K. may argue that the tax French-source income is not ‘‘payable in accordance with the Convention’’ and that therefore the Elimination of Double Taxation Article does not require it to give credit. The reasoning would be that the Business Profits Article precludes Under the DTT, U.K. resident partners of a French French tax on the partner’s share of the partnership partnership will be subject to French income tax with- income unless the partner is carrying on business out restriction. The Kingroup case law is respected, and through a PE in France. A U.K. partner in this situa- transparency is not recognized here. The partners will tion may have to apply under the mutual agreement also be subject to U.K. tax (which is not precluded), procedure for a remedy for its double taxation. In this but paragraph 5 of the protocol should apply so that respect, the new DTT is a significant improvement the U.K. will give credit for the French tax paid. compared with the current situation. While this solution protects the taxpayer, as with the 3. Article 4.5(d) article 4.5(b) scenario, it is perhaps surprising that the Article 4.5(d) addresses the case in which the state U.K. effectively concedes to France the right to tax of residence of the partner (France) does not recognize U.K. resident partners in this situation. the transparency of a partnership established in the This article seems to apply the solution provided in other state (the U.K.). (See Figure 4.) In this scenario example 17 of the OECD report on partnerships. In the income is ‘‘not eligible for the benefits of the Con- this example, the OECD report addresses the case of a vention.’’ This means that the protection afforded by partnership established in a state (State P) that treats the Business Profits Article, the Elimination of Double the partnership as an opaque entity (as a corporation) Taxation Article, and the various exemptions and re- while the state of residence of the partners (State R) duced rates of withholding tax will not apply. treats it as a transparent entity. In principle, State P This provision seeks to give effect to the conclusions would impose tax on the income received by the part- of example 6 of the OECD report. The conclusion in nership, and State R would also tax the partners on the example 6 is that the U.K. (in this example) should not same income. There would be double taxation on the be required to give the benefits of the convention. same item of income. The report notes that despite the general objective of elimination of double taxation, State P should not be required to take into considera- tion the treatment of the income in the state of resi- 27OECD report on partnerships, no. 131, supra note 17.

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provided for by the DTT in the U.K.28 There would (C) Tax Analysts 2009. All rights reserved. does not claim copyright in any public domain or third party content. Figure 4. Article 4.5(d) clearly be a risk of double nontaxation. The solution in article 4.5(d) is that the income ‘‘is not eligible for the benefits of the Convention,’’ which French means, for instance, that the U.K. may impose with- partner holding tax at the rates applicable under its domestic law. This conclusion is consistent with the rationale of France example 6 of the OECD report. In case of distribution by the LLP, the income will U.K. in principle be taxable in France as a dividend paid by an opaque company.29 France will not grant any tax credit for the U.K. tax withheld at source on the income received by the partnership, which will effectively U.K. result in double taxation. partnership Regarding law firms organized as an LLP, the French tax administration accepted in a tax ruling that French partners be taxed on a current basis by assimi- lation to the tax treatment in France of an U.K. GP described below.30 U.K.-source income 5. U.K. GP — Possible Double Taxation Under the existing treaty, when the partner of a GP is a French company subject to corporate income tax, the partnership income will not be taxable in France Example 6 deals with the case in which the state of according to French territoriality rules, while the U.K. residence of the partners views the partnership as would apply the withholding tax exemption/reduced opaque while the state of establishment of the partner- rate.31 Article 4.5(d) closes the possible double exemp- ship views the partnership as transparent. Example 6 is tion by providing that the DTT will not be applicable drawn up on the basis that France (in this example) to U.K.-source income received by the GP despite its will not tax the partners, which may result in double French partners. nontaxation. This is why the OECD report recom- When the partner is an individual, France will, in mends that the income should not benefit from the principle, tax the partner on the partnership income DTT. It is understood that under the existing treaty, because the individual is taxable on a worldwide basis, there is a possible double exemption for U.K. LLPs and so the double exemption does not arise. Still, ac- receiving passive income or U.K. general partnerships cording to article 4.5(d), the income will not be eligible (GPs) with French corporate partners. (See below for for the benefit of the convention: U.K. tax will be ap- how this could arise.) However, because the article applicable to U.K.-source income under the domestic tax plies to all forms of U.K. partnership, it also applies to rates. There is a risk of double taxation in this case. cases for which there is no double tax exemption, such as GPs with individual partners, for which France will Paragraph 3 of the protocol addresses the risk when in some cases tax the partners under domestic law. the GP is engaged in a trade or business in the U.K. Under that paragraph, if the U.K. partnership has a PE 4. U.K. LLP — Former Double Exemption in the U.K., the French partners are deemed to have a PE in the U.K. The income derived from the PE is As mentioned above, a foreign partnership will be thus exempt from French tax. Thus, the French partner treated as a corporation in France if the partners have will not be taxable on the income derived by the GP limited liability. The French partner of an LLP would from that business. not be taxable in France on its share of the partnership’s income (if not actually distributed) because the partnership is viewed as opaque. 28The U.K. may seek to employ the arguments set out in ex- Because the partnership is viewed as transparent in ample 6 to the effect that the treaty does not require it to grant the U.K., the U.K.-source income of the partnership exemption from withholding tax (for example, that the partners would in principle not be taxed. In the absence of ar- are not the beneficial owners of the income). It is doubtful ticle 4.5(d), the French partner would benefit from (1) whether those arguments would succeed. a domestic tax exemption in France (or at least a defer- 29Article 120-2 of the French Tax Code. ral until an effective distribution by the partnership) 30Res. No. 2007/28. and (2) the withholding tax exemption/reduced rate 31D. adm., 4H1422, no. 57.

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When the GP receives passive income, France (C) Tax Analysts 2009. All rights reserved. does not claim copyright in any public domain or third party content. would not grant any tax relief for the U.K. withhold- Figure 5. Article 4.5(e) ing tax. Under a tax treaty based on the OECD model convention, on the other hand, the U.K. would have applied the reduced rates applicable under the tax treaty, and it is thought that France would have U.K. partner granted a tax credit corresponding to the U.K. tax. The following example illustrates the problems that U.K. the excessive width of article 4.5(d) creates. U.K.-source interest is payable to a U.K. GP with French resident individuals as partners. This is a situation that could arise in the context of private equity fund structures. As article 4.5(d) removes the treaty exemption, a U.K. borrower will be required to withhold and account for tax at the current rate of 20 per- Third- cent. country France will tax the individual partners of the U.K. partnership GP on the income but is not required to give any relief on the tax withheld, because the DTT is not applicable. The result is double taxation. Even in the LLP situation, in which no double taxation arises (as long as the LLP does not distribute its France income) as a result of the removal of the withholding tax exemption, there is likely to be an issue for U.K. French-source income borrowers from LLPs with French partners. This is because it is likely that loan documentation applicable to any existing arrangements will require a U.K. borrower to gross up (or prepay) for additional withhold- longer be generally of practical effect to partnerships ing tax imposed following ratification of the DTT. for French tax purposes after the issuance of the 2007 guidelines in France.32 It would perhaps have been preferable for France to recognize the transparency of LLPs, so that the U.K. For U.K. tax purposes, this is the scenario that faced practice of disregarding partnerships for the purposes the Court of Appeal in Memec, in which the question of applying treaty relief from withholding tax could be before the court was whether relief for underlying tax maintained. relief could be claimed by a U.K. partner for dividends C. Triangular Cases derived through a German silent partnership. In that case, relief was not available because the German part- 1. Article 4.5(e) — The New DTT nership was not sufficiently similar to a U.K. partner- In this scenario, French-source income is paid to a ship (in other words, it was characterized as opaque U.K. partner through a partnership established in a rather than transparent for U.K. tax purposes). Had the third country. (See Figure 5.) Article 4.5(e) addresses situation arisen regarding a transparent entity, relief the case in which the source state does not recognize would have been available. the transparency of the partnership. In this case, the income will nonetheless benefit from the DTT as if it Article 4.5(e) applies only if the income is treated as were received directly by the partners, provided that: the income of the members under U.K. tax law, which will not be the case if the partnership is treated as • the partnership is viewed as transparent in the opaque on Memec principles. For a U.K. partner seek- state of residence of the partners; ing to claim relief under the DTT, there are now two • the partnership is viewed as transparent in the additional hurdles that must be crossed: third state; and • there is an agreement between France and the third state containing a provision for the exchange 32Under French domestic tax law, France will respect the full of information with a view to the prevention of transparency of the partnership provided that: fiscal evasion. • the partnership is established in a country that has con- cluded a tax treaty with France with an exchange of As in the article 4.5(a) scenario, article 4.5(e) ad- information provision; and dresses the case when the source state does not recog- • the third state also recognizes the transparency of the nize the transparency of the partnership and will no partnership.

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• the partnership must be transparent under the tax (C) Tax Analysts 2009. All rights reserved. does not claim copyright in any public domain or third party content. law of the third state; and Figure 6. Article 4.5(f) • there must be an agreement between France and the third state containing a provision for the ex- French change of information with a view to the preven- partner tion of fiscal evasion. It is difficult to see the logic of the first condition in France particular from the point of view of a U.K. partner.33 If this condition is not met, the implication must be that the U.K. partners cannot claim the benefit of the treaty, although a U.K. partner may argue that rather than expressly denying him the benefit of the DTT in this scenario, the DTT is simply silent on the point, and he should be able to argue his case on general principles, at least as far as relief granted by the U.K. Third- is concerned. country 2. Article 4.5(e) — The Existing Treaty partnership It is thought that the Memec test would apply as described above and that if the partnership were sufficiently similar to a U.K. partnership, a U.K. tax credit would be available for the underlying tax in accordance with the treaty. The French tax analysis and the tax U.K. analysis of the country where the partnership is established would be irrelevant. U.K.-source income According to Diebold case law and the administrative guidelines under this case, France would apply the existing treaty, for example, in granting reduced rates of also applies to partnerships established in a state other withholding tax, on the same conditions as those in- than France or the U.K. (See Figure 6.) The difficulties cluded in the DTT (tax treaty with exchange of information and transparency recognized by the third state). described above therefore cannot be avoided (or the advantage of double exemption obtained) by using a 3. Article 4.5(f) — The New DTT non-U.K. partnership. This extends the restriction on availability of treaty benefits of U.K. partnerships in article 4.5(d) so that it 4. Article 4.5(f) — The Existing Treaty

Provided the partnership is considered to be transparent on the Memec principles, the U.K. and French 33This condition is not included in the new protocol amend- analysis will be the same as set out in relation to ar- ing the tax treaty between France and the United States dated ticle 4.5(d) above. ◆ January 13, 2009.

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