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Political agreement on Danish termination of the tax treaty between Denmark and France
1. Executive Summary
The Danish government has on 27 June 2007 announced that a political agreement has been reached between a vast majority of the parties of the Danish Parliament which inter alia entails that the Danish minister of taxation following enactment of a bill not yet submitted to Parliament will be entitled to terminate the tax treaty between Denmark and France of 1957 (the "Tax Treaty"), effective as of 1 January 2009 (worst case).
Termination of the Tax Treaty is likely to affect existing and future real estate ownership structures in which a Danish company directly holds real estate in France, but would ultimately depend on the content of a new tax treaty between Denmark and France, if agreed.
As the effects of the termination of the Tax Treaty would not take effect until 1 January 2009, we expect that Danish companies currently directly holding real estate in France would generally be able to unwind these structures prior to 2009 in a tax efficient manner.
2.1 Agreement on new Danish pension tax scheme
On 27 June 2007 the Danish government announced that a political agreement has been reached regarding the future Danish pension taxation with a vast majority of the political parties in the Parliament, including the majority of the current opposition.
The agreement follows a long period of contemplation on how to amend the existing Danish pension tax regime which was deemed by the European Court of Justice to be in violation of EU community law cf. case C-150/04 of 30 January 2007 (Commission vs. Denmark).
In addition to a substantial amendment of the Danish pension tax system following a decision form from the European Court of Justice in January 2007 the political agreement includes an authorization to the present government to introduce a bill to the Danish Parliament according to which the minister of taxation is authorized to terminate the Tax Treaty (and the tax treaty with Spain).
According to Tax Treaty (and the tax treaty with Spain) Denmark is not entitled to tax pension payments from Danish pension funds to Danish pension savers that subsequently has taken up residence in France (or Spain). The Danish pension savers will therefore as a general rule have obtained full tax deduction in Denmark with a tax value of up to 59 per cent of their contributions to a pension scheme in a Danish pension fund. If the pension savers are resident in France and Spain when the pension payments are made such pension payments will normally be taxed in France and Spain at tax rates between 10 and 20 per cent.
The reason for the contemplated termination of the Tax Treaty (and the tax treaty with Spain) is to ensure that Denmark obtains a right to tax pension payments from pension schemes established with Danish residents which would provide for coherence in the Danish pension tax regime (deduction upon contribution and taxation at receipt of payment). Denmark has for decades wished to renegotiate the Tax Treaty but the attempts have so far been unsuccessful.
2.2 Timing Issues - Danish domestic law
Under Danish domestic law, termination of the Tax Treaty would require that the Danish parliament enacts an authorisation to the Danish minister of taxation to terminate Tax Treaty. The bill enacting the authorisation to the Danish minister of taxation has not yet been introduced to the Parliament which is currently on summer break but is expected to be introduced during autumn of 2007 when the parliament reassembles, i.e. in October or November of 2007. A bill authorizing the minister of taxation to terminate the Tax Treaty can therefore not be expected to be passed by the Parliament until November or December 2007 at the earliest.
Speculations of election to Parliament (which would render invalid any bill introduced but not yet adopted by the Parliament) have circulated in the press for some time. However, as the majority of the current opposition is part of the political agreement, a new government is not likely to change the current course. An election might, however, delay the enactment of the authorisation to the Danish minister of taxation due to the fact that the bill would need to be reintroduced following an election.
2.3 Timing Issues - Article 28 of the tax treaty between Denmark and France
Article 28 of the Tax Treaty reads as follows:
"This Convention shall remain in force indefinitely.
Either of the Contracting States may, however, on or after January 1, 1960, notify the other Contracting State during the first six months of any year in writing and through the diplomatic channel, of its intention to terminate the Convention. In such a case, the Convention shall cease to have effect from January 1 of the year following that in which notice is given, it being understood that its [the Convention] effect shall be limited:
(a) as respects taxes deducted at the source on income from movable capital, to the taxation of income payable in the year in which notice was given;
(b) as respects taxes on other income, to the taxation of income pertaining to the year in which notice was given or to the financial years ending in the course of that year;
(c) as respects taxes on capital, to the taxation of capital existing on December 31 of the year in which notice was given or on the last day of financial years ending in the course of that year."
Accordingly, Denmark is entitled to give notice of termination within the first 6 months of a calendar year and such termination will take effect from the first of January the following calendar year. This means that the tax treaty with France can at the earliest be terminated with effect from 1 January 2009.
Form our reading of article 28(b) if the Tax Treaty is terminated within the first 6 month of 2008 this would entail that the Tax Treaty would still be in effect and apply to corporate income in a Danish entity until end of the calendar year 2008.
2.4 What is going to happen ?
The terms and conditions for the authorisation to the Danish minister of taxation to terminate the Tax Treaty is yet unknown and it is therefore not fully clear whether the authorisation is intended to lead to actual termination of the Tax Treaty as soon as possible. Further, at this stage no political signals or analysis other than as expressed in the agreement have to our knowledge been published.
On one hand termination of the Tax Treaty is a very significant step with many repercussions other than taxation of Danish pension savings. Further, only once before in recent Danish history has Denmark gone as far as terminating an existing tax treaty and never with a tax treaty partner which has an economic importance to Denmark comparable to France.
On the other hand, the wording of the announced agreement assumes that renegotiations of a new tax treaty with France will be initiated following a termination of the existing treaty which would indicate that Denmark has a strong intention of terminating the Tax Treaty, unless the present negotiations with France are intensified and, as a minimum, lead to a provision on taxation of Danish pension tax, which is satisfactory for Denmark.
If a new tax treaty is negotiated with France such treaty is likely to be based essentially on the OECD model albeit with exemptions, inter alia regarding taxation of private pension schemes. If the Tax Treaty is modified to accommodate Danish wishes on taxation of pension schemes, in is very difficult to predict which other changes would be made. There is - also in this scenario - a reasonable possibility that a number of treaty provisions would be aligned with the OECD model, inter alia the provision taxation of income and capital gains from real estate and permanent establishments.
2.5 Effects on existing real estate structures
From a Danish tax perspective, termination of the tax treaty between Denmark and France will not change the tax-exemption of Danish companies currently directly holding real estate in France by virtue of the territorial principle applicable under Danish domestic tax law. Indeed, these companies will still be comprised by the Danish territorial principle applicable to taxation of income (and capital gains) from permanent establishments and real estate abroad when Denmark has not been granted a right of taxation under a tax treaty or other international convention. Accordingly, if no tax treaty exists between Denmark and France, no such right of taxation has been granted to Denmark.
However, we understand that termination of the Tax Treaty could give rise to taxation in France, as France would then not consider itself as being prevented from taxing real estate situated in France when owned by a Danish company. This should, however, be confirmed with French tax counsel.
As the effects of the termination of the Tax Treaty would not take effect until 1 January 2009, we expect that Danish companies currently directly holding real estate in France would generally be able to unwind these structures prior to 2009 in a tax efficient manner from a Danish tax perspective. We are of course prepared to elaborate further on this issue and engage in any specific matters on request.
Bech-Bruun is monitoring developments closely and we will of course keep you updated on any significant developments with respect to the Tax Treaty.