Vidya Ram

The tax wars of Europe

VIDYA RAM | Updated on November 27, 2014 Published on November 27, 2014

The ‘Luxemburg Leaks’ is a disturbing pointer to the urgent need to check EU’s tax haven conundrum

Earlier this month, the tiny EU state of Luxembourg found itself at the centre of global controversy as details of the ultra-favourable tax deals it struck with over 340 multinational companies, including PepsiCo, Ikea and FedEx (so far no Indian firms have been named), emerged as the result of what have come to be known as the “Luxembourg Leaks” — some 28,000 pages of documents obtained and analysed by the International Consortium of Investigative Journalists, a network of 185 investigative journalists across the world.

While Luxembourg has long been known for its light-touch tax regime, the scale of a system under which foreign companies were able to escape billions in tax dollars, paying as little as 1 per cent tax through Advance Tax Agreements, negotiated by PricewaterhouseCoopers on behalf of the client, was startling to many.

Awkward deals

The leaks were particularly revealing in two significant ways says Professor Ronen Palan, co-author of Tax Havens: How Globalization Really Works. “We now know that the four accounting firms are at the heart of tax avoidance,” he said during a telephone interview. “We have thought they were at the heart of it but here you have evidence of it,” he said.

The “totally unacceptable” revelations about the systematic use of pre-negotiated advance tax agreements to enable firms to be offered effectively near-zero rates of tax in exchange for investment was also noteworthy, says Professor Palan.

The Lux Leaks have proved particularly awkward for Jean Claude Juncker, who took over as president of the European Commission at the start of November. Many of the “comfort” agreements had been struck during his tenure as prime minister of Luxembourg between 1995 and 2013.

Could a leader who had helped companies cut their tax bills at the cost of other sovereign states — and to the benefit of Luxembourg’s coffers — be the right person to lead the EU, a region where many states remain under pressure to maintain tough austerity regimes while facing high levels of unemployment and faltering growth?

Luxembourg has undoubtedly benefited from its attractiveness to MNCs — the OECD estimates that the 500,000-person strong state has the highest economic output per capita of any country in the world — at $112,473 a person in 2013 (Britain’s, for example, is less than half this figure).

It is all the more awkward for Juncker, who, according to the ICIJ, pledged to put “some morality, some ethics, into the European tax landscape,” in a speech in July before he took over the presidency.

“Europe’s problem is that states such as Luxembourg have put tax competition at the heart of their growth strategy,” says John Christensen, director of the international research and advocacy group, the Tax Justice Network Ltd, who argues that “war” rather than “competition” is a more accurate description. “These are tax wars where one county is using its tax sovereignty to undermine the tax sovereignty of another.”

He points out that this undermines the premise the European project. “The whole purpose of regional free trade areas is to allow capital to move to where it is most productive but here capital is being subsidized to move to where tax conditions are most favourable.”

Just can’t control

The Lux Leaks have also highlighted the current limitations on the EU’s ability to challenge the growth of what are effectively tax havens in its midst. The EU’s powerful economic and financial reach does not extend to the taxation of individuals and corporations, over which power remains in the hands of domestic governments — and there are no rules that could curb a state’s ability to attract investment from overseas through a favourable tax regime.

While a Code of Conduct for Business taxation was set out in 1997, encouraging member states to roll back existing “harmful tax competition” measures and refrain from bringing in new ones, it is non-binding and has done little to restrain from governments from acting solely in national interests.

The most powerful tools that the EU has to tackle sweetheart tax deals are those that enable it to curb state aid: while the EU permits state aid in certain situations (for example it allowed some states to help out banks in deep trouble during the financial crisis) it is mostly illegal for countries to use “taxpayer-funded resources to provide assistance to one or more organisations in a way that gives advantage over others.”

It is currently using its state aid rules to investigate tax agreements struck between Ireland and Apple, the Netherlands and Starbucks and Fiat Finance and Luxembourg. Whether its inquiry will be extended in the wake of the latest Luxembourg revelations remains to be seen.

There have also been measures to bring in transparency, particularly when it comes to the taxation of individuals. Earlier this year, Luxembourg and Austria agreed to join in the scheme for the automatic sharing of information on interest income across the region, set up over a decade ago.

For transparency

There are moves to increase the transparency for corporates too, though, as Palan points out transparency will only change matters to a limited degree, given that often companies are only too willing to accept that they use loophole, pointing to the fact that they are entirely legal.

While Europe does not have a monopoly on tax havens, tackling those within it is particularly important in the global battle for tax justice, given the huge advantages EU membership bestows on such states and their ability to attract funds.

Palan points out that states such as Luxembourg offer the political stability that many look for (and which many tiny island tax havens may lack) as well as the externalisation of costs for matters such as currency or security. Crucially, as the case of Juncker has shown, it gives them a powerful voice globally in determining tax policy.

Still campaigners for change are optimistic. Christensen points to progress such as the Netherland’s decision to review its double taxation agreements with developing nations following criticisms that these often enabled companies to avoid tax, as an example of the impact public pressure can have and is having.

“The gradualist approach of organisations such as the G20 and the EU have so far failed — and anger is increasing — not just about the lack of investment but the skewing of growth and massive concentration of wealth. The political pressure for change is huge,” he says.

Published on November 27, 2014
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