A French employee seconded to Germany receives his payslip and discovers a German withholding tax. At the same time, the French tax administration is demanding tax on the same salary. Two countries, one income, two taxes. This is exactly the type of situation that international tax treaties aim to resolve.
Concrete Mechanism for Eliminating Double Taxation
Before discussing definitions, let’s look at how a taxpayer is protected in practice. Two methods coexist in most treaties signed by France.
The first, known as the exemption method, involves exempting the income in one of the two states. The country of residence waives taxing income that has already been taxed in the source country. The taxpayer only pays tax once.
The second, known as the tax credit method, works differently. The country of residence maintains taxation but deducts the tax already paid abroad. If the German tax reaches a certain amount, France offsets this amount against the French tax due. The taxpayer does not face an additional burden.
France uses both methods depending on the treaties and the categories of income involved. A dividend received from a partner state does not necessarily follow the same rule as a salary or a pension. Each treaty allocates taxing rights income by income, making careful reading of the applicable text essential.
To delve deeper into the definition of an international tax treaty on Buzzorama, the treatment also varies depending on whether the taxpayer is a tax resident of one state or the other, a notion that the treaty itself specifies with its own criteria.
Tax Residence in Treaties: The Deciding Criteria
You are registered in the commercial register in France and spend six months a year in Portugal. Where are you taxable? The domestic law of each country may consider you a resident. The tax treaty then comes into play with a series of hierarchical criteria to resolve this conflict.
These criteria, inspired by the OECD model, follow a precise order:
- The permanent home: the state where the taxpayer has a durable housing as their primary residence.
- The center of vital interests: the state with which personal and economic ties are closest (family, professional activity, assets).
- The habitual abode: if the previous two criteria do not resolve the issue, the number of days spent in each state is compared.
- Nationality: the last resort before an amicable procedure between the two tax administrations.
This cascade of criteria, often referred to as the “tie-breaker rule,” is a tool specific to treaties. Domestic law alone does not resolve residency conflicts between two states. Without a treaty, each country applies its own definition, and the taxpayer remains caught in a bind.
Anti-Abuse Clauses and Global Minimum Tax: What Has Recently Changed
Tax treaties no longer serve solely to protect taxpayers from double taxation. They now incorporate provisions to prevent double non-taxation, meaning arrangements that allow one to be taxed nowhere.
France has finalized updates to its agreements with several major countries to incorporate BEPS standards. These revisions focus on three main axes:
Broadening the Definition of Permanent Establishment
The revised treaties with partners like the United Kingdom or Singapore redefine permanent establishment to cover digital business models. A company generating significant revenue in a state without having a physical office can now be taxed there, where the previous wording did not allow it.
Main Purpose Test Clause
This clause allows a tax administration to deny the benefits of a treaty if the main purpose of an arrangement is to obtain a tax advantage. For example, creating an intermediary company in a state solely to benefit from a reduced withholding tax rate on dividends can be reclassified, and the advantage denied.
Mauritius recently saw this mechanism applied in the context of its treaty with India, with arrangements deemed abusive by Indian authorities.
Alignment with the 15% Global Minimum Tax
The revised treaties must also coexist with Pillar Two of the OECD framework, which provides for a minimum tax of 15% for large multinationals. If a subsidiary is taxed below this threshold in a partner state, the state of residence of the parent company can levy a supplementary tax. The treaty no longer obstructs this supplementary levy.
France-Germany Tax Treaty: Example of Practical Reading
Let’s take a concrete case. A French tax resident receives a salary from a German company for work performed in Germany. What does the Franco-German treaty say?
The article relating to employment income allocates the right to tax to the state where the activity is performed. Germany therefore taxes this salary. France, as the state of residence, grants a tax credit equal to the French tax corresponding to this income. The employee is not exempt in France, but he does not pay twice.
For real estate income, the logic differs. If this same French resident owns a rental property in Germany, the rental income is taxable in Germany. France also applies the tax credit method here, but the calculation may yield a different result depending on the effective tax rate in each country.
What makes reading a treaty tricky is that each category of income (salaries, dividends, interest, royalties, capital gains, pensions) has its own article with specific allocation rules. Reading only the article on residence is not sufficient: it is necessary to cross-reference with the article corresponding to the nature of the income.
France has a network of over a hundred bilateral treaties. Each has its particularities, negotiated withholding tax rates, and exceptions. No treaty is identical to another, even though the OECD model serves as a common base for most of them.
A taxpayer facing a cross-border situation benefits from first identifying the applicable treaty, then the article corresponding to their type of income, before checking the method for eliminating double taxation chosen. This three-step approach avoids most reporting errors.