Tax treaties: avoiding double taxation (method and tax credit)

Quick answer. A bilateral tax treaty allocates the right to tax an income between two countries and eliminates double taxation by one of two methods: exemption (the residence country does not tax income already taxed abroad, sometimes keeping it to set the rate applicable to other income) or the tax credit (both countries tax, but the residence country grants a credit representing the foreign tax). France most often uses the ordinary credit, where the credit is capped. The starting point is tax residence (Article 4 B of the French tax code, supplemented by the treaty's criteria). The treaty prevails over domestic law.

Directors holding foreign shareholdings, mobile employees, investors receiving foreign dividends: cross-border situations are multiplying. The risk? That the same income is taxed twice, in the source country and in the residence country. Tax treaties exist precisely to avoid this. Knowing how to read them has become a wealth-planning reflex, alongside the status choices we describe in our matrix on expatriate, posted or inbound.

A tax treaty is a bilateral agreement signed between two States to allocate the right to tax and eliminate double taxation. France has concluded a broad network of more than a hundred treaties, most often based on the OECD model. Two principles structure their application:

• Primacy over domestic law. Under the hierarchy of norms, the treaty prevails over national tax law.
• Subsidiarity. Domestic law is applied first to determine the tax, then the treaty to eliminate, where applicable, the double taxation.

The two principles complement each other: the treaty prevails over conflicting domestic law, but it is only invoked after the tax has been established under domestic law.

It all starts with tax residence, which determines which State can tax all the income. Under French law, Article 4 B of the tax code retains several alternative criteria:

• the home or main place of stay in France;
• carrying on a professional activity in France as the main activity;
• the centre of economic interests in France.

In case of dual residence (each country considering you a resident), the treaty decides through a cascade of criteria: permanent home, centre of vital interests, habitual abode, then nationality. It is a factual analysis, decisive for everything that follows.

Treaties use two main methods.

• The exemption method. The residence country does not tax the income already taxed in the other State. Often, however, it takes it into account to compute the effective rate applicable to other income (the exempt income "raises" the rate, without itself being taxed).
• The tax-credit method. Both States tax the income, but the residence country grants a tax credit. A distinction is made between full credit (credit equal to the foreign tax) and the ordinary credit (credit capped at the amount the residence country would have collected). France most often uses the ordinary credit.

Depending on the treaty and the category of income, the tax credit may equal the corresponding French tax (which neutralises the French tax) or the tax actually paid abroad: it is the treaty that must be read, line by line.

Some passive income — dividends, interest, royalties — may be subject to a withholding tax in the source State, at a reduced rate set by the treaty (often lower than the domestic rate). This withholding then grants, in the residence State, a creditable tax credit that avoids double taxation. The reduced treaty rate nonetheless requires formalities (forms, residence certificates).

1. Determine tax residence, under domestic law then, in case of conflict, under the treaty's criteria.
2. Identify the applicable treaty between France and the other country.
3. Qualify the income (salary, dividend, profit, property income, royalty): each category has its allocation rule.
4. Apply the method provided (exemption or tax credit) to eliminate the double taxation.
5. Declare correctly the income and tax credits in each country, keeping the supporting documents.

The director with international income. Holding a foreign subsidiary or receiving foreign dividends requires articulating the treaty, the withholding tax and the tax credit, consistent with director's wealth management.

The mobile employee. The place of taxation of the salary depends on the treaty and the number of days worked; the subject connects to the taxation of remote work abroad.

The foreign company active in France. Its situation is read in light of the treaty and the notion of permanent establishment, alongside keeping the accounts of a foreign company in France.

• Start with tax residence. It determines which country taxes: do not skip it.
• Read the treaty, category by category. Salaries, dividends, profits, property income follow distinct rules.
• Don't confuse exemption and tax credit. Both eliminate double taxation, but with different effects on the rate and the amount.
• Comply with withholding-tax formalities. The reduced treaty rate often requires a residence certificate.
• Follow treaty developments. The treaty network evolves; check the applicable version, as we do in our watch on tax news.

Recently, a director receiving dividends from a foreign company worried about being taxed twice. The analysis followed the method: confirm his French tax residence, identify the applicable treaty, qualify the income (dividend), note the withholding tax applied abroad and compute the tax credit creditable in France. The double taxation was eliminated, but at the cost of a precise reading of the treaty and compliance with the withholding-tax formalities, which had not been anticipated in the first year.

Our conviction, as accountants registered with the Ordre, is that double taxation is not inevitable: it is neutralised by a rigorous method and a good reading of the applicable treaty. The most frequent mistake is to reason "country by country" without articulating residence, treaty and tax credit. It is technical work we carry out within international tax advice.

Hayot Expertise advice. Faced with cross-border income, always follow the same order: first determine your tax residence, identify the applicable treaty, qualify the income, then apply the elimination method (exemption or tax credit). For dividends, interest and royalties, check the treaty withholding-tax rate and the formalities to complete. Keep all supporting documents. Double taxation is prevented; it is far harder to correct after the fact.