dodgy duchy

Luxembourg’s Shady Business Model

Bockfelsen und Oberstadt mit der Kirche St. Michael, view on the uptown with St. Michael and the Bock rock
Luxembourg, Europe's picturesque tax haven.
  • Why it matters

    Why it matters

    With a global effort to crack down on tax evasion underway, incoming Commission President Juncker will face pressure to act tough on his homeland.

  • Facts

    Facts

    • The European Union is investigating Luxembourg for effectively providing state aid to online retail giant Amazon.
    • The E.U. Commission says a tax agreement in 2003 known as a “ruling” allowed the company to significantly reduce its tax liability.
    • The Commission is already investigating Ireland and the Netherlands for similar breaches of E.U. rules.
  • Audio

    Audio

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Which European Union country attracts the most investment money from other countries? The answer: Luxembourg.  Of the €370 billion ($466 billion) invested in 2013, €240 billion went to the tiny country bordering Germany, France and Belgium.

The next question: Which E.U. country invests most in other member states? The answer: Luxembourg again. A total of €213 billion came from the tiny duchy – a good three quarters of all European Union direct investment.

The home country of incoming European Commission president, Jean-Claude Juncker, leaves other countries in the shade when it comes to being a finance center. Almost every private equity company, most multinationals, along with nearly every U.S. pension fund and insurer make sure their money flows through the tiny state when it comes to doing business into and out of Europe.

“Luxembourg: Where else?” is the title of a PwC brochure that mentions “tailor-made” rules for companies and a “total tax rate” that is lower than Ireland’s and only around 40 percent of Germany’s.

“As Luxembourg’s finance minister and prime minister for 20 years, Mr. Juncker prevented progress on the fight against tax avoidance and evasion – to the detriment of Germany and France.”

Sven Giegold, German Green Member of the European Parliament

And of all people, the politician who helped create this tax haven is now set to become the new head of the European Union executive. As part of the campaign for this May’s European Parliament election, it was Mr. Juncker who said: “Tax evasion and tax havens have no place in Europe.”

It was a slogan that found resonance among many European voters. In an era when millions of people feel their lives are being affected by the state’s austerity measures, the announcement that tax loopholes are to be closed and thus more justice achieved will surely be well-received in nearly every European country.

Has the Luxembourg president had a change of heart? At least Mr. Juncker is sticking to his latest line: “While we recognize member states’ responsibility for their tax systems, we have to strengthen our efforts in the fight against tax avoidance and tax evasion, so that everyone pays their equal share,” he told the European Parliament as he presented his program for the coming five years.

But what will happen when he finally moves into his office on the 13th floor of the Berlaymont building in Brussels?

Mr. Juncker said he chose the former French Finance Minister, Pierre Moscovici, to be his commissioner for economics, finance and taxation, because he believed a Frenchman would be in the best position to make sure the French stick to the euro zone’s stability criteria. But then wouldn’t a Luxembourger be best placed to end Luxembourg’s days as a tax haven?

There are many skeptics when it comes to that question. “As Luxembourg’s finance minister and prime minister for 20 years, he prevented progress on the fight against tax avoidance and evasion – to the detriment of Germany and France,” said Sven Giegold, a Green member of the European Parliament.

At the same time, there has been some expectation in Luxembourg that its former prime minister might seek to protect the duchy and its business model from Brussels. “Juncker will have the guts to say that tax competition in Europe is desirable,” said George Bock, a partner with KPMG in Luxembourg.

BELGIUM-BRUSSELS-EU-JUNKER-COMMISSIONERS-RELEASE
Gearing up to head the commission. Source: DPA

 

KPMG is one of the companies that has advised Italian automakers Fiat on its tax affairs. In June, the European Competition Commissioner, Joaquín Almunia, opened a state aid investigation into Fiat Finance and Trade, the company’s Luxembourg finance subsidiary. The suspicion is that the Luxembourg tax authorities gave the company an individual tax rate.

On Tuesday Mr. Almunia’s office announced it was also investigating Amazon on whether it had breached the bloc’s rules on state aid. The E.U. competition authorities looked at a 2003 ruling by the Luxembourg tax authorities for Amazon’s subsidiary Amazon EU Sarl. Under that ruling, the European subsidiary was allowed to pay a royalty to its parent company and thus reduce its taxable profits. This move, according to the competition authorities, constituted state aid, which is illegal in the European Union.

As in similar cases against Apple in Ireland and Starbucks in the Netherlands, the European Commission suspects that companies have set the prices for services within the company at such a level that the foreign subsidiaries in the rest of Europe have little profit left over to be taxed.

This is made possible by so-called “rulings,” which essentially are private agreements between tax authorities and companies and form the basis of the Luxembourg model.

Worth noting, the nominal corporation tax rate in Luxembourg is 29 percent, almost as high as in Germany, a fact that doesn’t necessarily make the country attractive as a tax haven. It is the many “rulings” that lead to the extremely low assessment base, which can then push down the tax rate to the low single-digit percentage level.

An OECD report last year on 93 countries found that Luxembourg did not meet international standards of transparency and the exchange of information in terms of taxation issues.

The particularly friendly treatment includes a range of different regulations, according to Asmus Mihm of the international law firm Allen & Overy. Luxembourg, he said, offers a host of tax exemptions, such as “participation exemption” for dividend income and gains on the disposal of investments. This practice is important for hedge funds and private equity companies, which buy up struggling companies cheaply, restructure them and sell them on at a profit.

To secure these tax-free “exits,” managers of these fund come to an agreement on the relevant rulings with the Luxembourg tax authorities before buying the company. The authorities, in turn, don’t impose any withholding tax on particular convertible bonds and participating bonds, making the country attractive as more than just a platform for U.S. hedge funds and private equity funds.

The entire approach of the tax authorities and regulators in Luxembourg are more “customer-orientated and more benevolent” than in Germany, for example, said Mr. Mihm of Allen & Overy.

By resorting to competition law against Luxembourg, Ireland and the Netherlands, the Commission is using one of its most powerful instruments because the Brussels authority can decide itself if it wants to impose any fines.

The Commission is taking this approach because if it is a question of tax policy, then the member states must reach a unanimous agreement, which is not likely. For years, the three countries in question have blocked the work of the E.U. Code of Conduct Group on corporate tax.

The European Commission has opened infringement proceedings against Luxembourg because, unlike Ireland and the Netherlands, the country has failed to provide the necessary documentation from the tax authorities. The Commission will have to apply pressure. After all, secrecy is part of Luxembourg’s business model. An OECD report last year on 93 countries found that Luxembourg did not meet international standards of transparency and the exchange of information in terms of taxation issues.

Policy makers in Brussels are extremely interested in how Mr. Almunia’s successor as competition commissioner, the Dane Margether Vestager, will proceed with these cases. “As a Dane she will find it easier to handle than a Luxembourger,” said Markus Feber, a European Parliament lawmaker for Germany’s Christian Social Union party. Will her boss Mr. Juncker really let her to take a tough stance? Or will his vice president, Frans Timmermans of the Netherlands, who has also made his mark as someone with a creative, if not downright aggressive tax policy?

In Berlin, they are taking a wait-and-see approach. In the finance ministry, officials are talking of a “litmus test for Juncker.” Finance Minister Wolfgang Schäuble declined to comment on the issue. In the fight against companies’ aggressive tax optimization, which is only possible because of some countries’ tax advantages and loopholes, Mr. Schäuble is hoping for a joint political solution from OECD countries.

However, it is certain that the finance minister and his officials have been irritated at those times that, as prime minister of Luxembourg, Mr. Juncker, defended his country’s fiscal privileges. “When it comes to the financial transaction tax, Juncker has his foot firmly on the brake,” said Thomas Gambke, a Green Party member of Germany’s lower house of parliament, the Bundestag.

The planned tax on shares and derivatives was a way for politicians to make the finance industry share in the costs of the big financial crisis of 2008/2009 and of making fast speculative transactions more difficult. It is obvious that Luxembourg is not going to be happy with this: After all, the duchy is the second biggest location of funds in the world. Only New York is bigger. Why would Mr. Juncker want to change that?

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The article first appeared in WirtschaftsWoche. Christian Ramthun is a reporter based in Berlin and Silke Wettach is the magazine’s Brussels correspondent. To contact the authors: christian.ramthun@wiwo.de and silke.wettach@wiwo.de

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