Tax: Missing The Point in Luxembourg
Over the last few days an international investigation has hit the news following the leak of 28,000 tax documents from Luxembourg, mostly from PWC. It’s triggered a worldwide frenzy of journalistic and political criticism of Luxembourg’s political elite (and to some extent PWC). This is significant for the EU, because Jean-Claude Junker is the current President of the EU Commission (the executive branch), and yet when many of the above documents were written he was Prime Minister of Luxembourg. Worse than that in fact; after 18 years as PM Junker came out with a speech saying that as EU Commission President he would:
“Try to put some morality, some ethics, into the European tax landscape.”
So the story is now that we have a villain and a liar at the head of the EU, as well as a proven tax haven at the very heart of Europe (Luxembourg was one of the EU’s six founding countries). Indeed the news is now peppered with talk about pressure on Junker to step down. BUT, this story is both naive, and also the story that tax avoiders actually want you to buy into. It is a story which harms international cooperation, and prevents focus from being where it actually should be if we want to resolve the problem of lost tax money.
As argued in the tax debate, focus on individual countries, and especially on the political elites, is part of a false and misleading narrative. I work as a Luxembourg Tax Analyst full time (more to assist compliance with government legislation than advice provided to companies, but I know several tax advisors – some of whom work in PWC). In this capacity I have helped to re-organise one of the tax payments systems used. Do companies always pay the cited national level of Corporate Income Tax? No, annoyingly far from it. I remember coming home from work numerous times and complaining to my wife that even in nominal terms we pay many times the amount of tax paid by big corporations. But let me ask you this: do you think companies in the US pay the national rate? How about the rest of Europe outside of Luxembourg? Or indeed anywhere else?
Moreover, I also work as a Political advisor in my spare time. In that capacity I have analysed, and spoken to, a lot of different politicians. My experience is limited, and perhaps it would be different were I to circle with the true elites. But nonetheless, I have never encountered anyone who’s actually clued up about the way that the international tax system works. They all know it’s a problem. But in reality it’s just too complicated for most elected politicians to fully understand. So the problems get shunted off into the administrative elements of the tax system. These administrations are left to understand vague and ambiguous political directions, to which private institutions spend huge sums pandering towards. But, and this is why today’s story misses the point, Tax Administrations around the world all play by the same rules!
This story on the news right now pertains largely to ATAs (Advance Tax Agreements). Within the parameter of these agreements Tax Advisors recommend new structures to clients that will save them tax. Sometimes these structures are complicated. Other times they’re relatively simple. But every time one of these agreements is taken to the Tax Authority, the tax advisors can:
- Make an argument of comparison to cases in other countries (appealing to the country’s sense of competition within the rules of the international ‘game’)
- Use asymmetrical information to make their argument (local tax authorities have information about their state, and not others – it’s the tax advisors who come to the table having already analysed the big picture)
- Make a sales pitch based on whatever ambiguous political values come down from the political elite
Shire is a good example. It’s a multinational drug firm, specialising in treatments for ADHD, Crohn’s disease and rare genetic disorders. Its structure, set up upon advice from tax advisors, sees offices in Ireland, Jersey, the UK and the US. By paying internal loans between these offices (sub-businesses), Shire is able to avoid paying tax on interest payments from countries where tax is high, on the understanding that tax is paid where the interest income is received. But, based on a chart showing money flowing from the company’s headquarters in Ireland, through two Luxembourg sub-units, and ultimately to to other Shire companies around the world; the Luxembourg sub-units could be presented to the Luxembourg Tax Authorities as simply an intermediary between other, larger businesses elsewhere. As part of this presentation, tax advisors can draw up an Advance Tax Agreement (sometimes called a ‘comfort letter’). There, they argue that the onus of taxation falls not on Luxembourg, but really on the final recipients of the interest income, because the loans are really only flowing through Luxembourg.
To the Luxembourg Tax Authorities this idea of tax transparency seems quite normal. Most countries recognise tax transparent companies, where the onus of taxation is not on the company, but rather on the final beneficiaries from the company’s income. In other words the company exists for administrative purposes, and tax just flows through. Moreover, Luxembourg is of course a very small country. It seems easy to believe that it is indeed being treated as no more than a flow-through entity. Therefore, Luxembourg’s tax collectors agreed that they did not need to perform a rigorous tax assessment of Shire’s operations, because the assessments should really be performed elsewhere. Of course this is a very positive light in which to paint these activities. But what I wish to press is that these arguments are easily made, information is often incomplete, and similar things happen all the way around the world. Moreover, every single act now perceived to be immoral was perfectly legal, and not only that, but encouraged under the existing corporate and capitalist systems in place.
The American system of Corporate Governance is the one which dominates almost all global corporations (Germany is a sometimes cited exception because of the power it gives to employees, but even there the pattern of change is towards the global consensus, and not away from it), and it says that the corporation’s primary goal should always be maximising shareholder value. Given that this defines the goals of almost the entire global network of competing businesses, is it really any wonder that Shire was able to justify its actions as below?
“Shire Holdings Europe No.2 Sarl [the Luxembourg sub-unit], is part of our overall treasury operations. We have a responsibility to all our stakeholders to manage our business responsibly; this includes managing our tax affairs in the interest of all stakeholders.”
If someone beats you in Monopoly, do you cry out that they were cruel and unfair to leave you bankrupt? Of course not! They were supposed to do that, because that’s what the game asks. Besides, if you target one player in the game and continually criticise them as being unfair, then you will probably find that while you’re distracted, someone else is even more busily trying to bankrupt the both of you. This is why, when political leaders such as US President Barrack Obama and UK Prime Minister David Cameron come out in speeches labelling multi-national tax-avoiding corporations as “unpatriotic”, they sound to many in the corporate world like the Monopoly player whining about their losses, and in a world where they have as much power as anyone else to affect real change in the rules of the game. This is why it is crucial that we focus on tax reform where it matters most: in the arena of international taxation.
The OECD’s Base Erosion and Profit Shifting Initiative (BEPS) is trying to resolve problems such as these (and many others) right now. The latest update relating to BEPS came just a few days ago, with the OECD releasing a discussion draft pursuant to action 7 of BEPS, in which they call for changes to the definition of ‘Permanent Establishment’ (one of the legal requirements necessary to set up residence in a country). So let’s focus on initiatives such as this. Let’s bring them into the limelight. Let’s raise their profile. And let’s challenge their fundamental assumptions too. The OECD is effectively a rich country’s club, as you can see from the map below.
Talk about tax fairness is commonly about compliance with the OECD Convention, and the OECD’s rules on tax transparency (which countries like the UK and US are not compliant with). But what is not normally recognised is the fact that the OECD Model Convention stands contrary to several principles initially laid out in the 1928 League of Nations Treaty, and later promoted by Keynes when the Bretton Woods Institutions were being set up. These principles gave substantial taxing rights to source countries (where the income comes from). The OECD model benefits developed countries in which investors choose to reside their companies e.g. Luxembourg, the US, the UK, Switzerland, the Cayman Islands, Hong Kong and others. In fact the UN had to create an alternative model in 1980 to more fairly deal with the source countries.
If we’re going to be realistic about what we can do, and we do actually want to support tax fairness globally, and not just for ‘us’, whoever that us happens to be, then we’re going to have to:
- Bring the UN in on the BEPS initiative.
- Raise the profile of international tax
- Work towards a much broader state of cooperation, such that we can found an International Tax Organisation, with similar institutional capacities to the World Trade Organisation
The campaign for tax fairness is not a battle that can be fought and won. There will always be vested interests spending countless hours trying to find loopholes and exploit tricks of the system. An International Tax Organisation would ultimately be able to monitor these efforts, and provide assistance to all states seeking to protect their legitimate taxable incomes. But as that organisation is a long way off, then let us cooperate more on what is on the table today. And let us not turn to childish bickering and the age old classroom ‘blame game’. If we do go down that route i.e. the blame game; our problems will be worsened, not solved. The players don’t need to be changed. The rules do!