President Juncker is firefighting as Luxembourg burns

At a public consultation meeting held last week at The Chamber of Commerce in the presence of both the prime minister and the leader of the opposition questions were raised on a number of proposals on how to improve future economic growth.

Naturally one item on the agenda was the future of Malta’s tax regime and the consequential effect on possible changes on State Aid rules. A representative from a top big four audit firm politely asked the panel what is the state of play concerning the probe by Brussels into the regimes of a number of EU countries following the discovery of a tax scandal in Luxembourg

The prime minister reassured everyone that his government is fully in control of the situation and can assure members of the Chamber that in the case of Malta so far there were only requests for clarifications from Brussels.

Other countries under the spotlight include Ireland and the Netherlands, besides Luxembourg. This ruse came out at a time when the European Central Bank is probing 160 banks to check on their non performing loans and assess any impairment that may result.

As was revealed in the media by the chairman of Bank of Valetta the ECB is charging a seven figure fee for the recent audits conducted on its loan book and to assess the going concern aspect of its clients.

It is public knowledge that a lower rate of dividend was approved by BOV this year to make up for a €12 million under-provision for certain advances. It is not an exaggeration that banks in Malta which have all passed their stress tests in flying colours may yet be asked to increase capital buffers.

Moving to overseas banks one notes that analysts estimate the new capital requirements could cost €200bn for Europe’s banks alone, with the cost for globally significant banks in the US, Japan and China likely to be much higher.

In the UK, the banks that may be asked for additional capital injections include Barclays, Standard Chartered, HSBC and the Royal Bank of Scotland.

Back to Luxembourg, readers may ask what is the tiny Duchy up to that it has drawn the ire of Brussels and set forth an investigation into its alleged tax rules?

Going down memory lane one remembers how the tiny Duchy started operations after the war as a steel producing country with a modest economy but quoting Financial Times it now estimates that its burgeoning financial sector has grown from virtually nothing 30 years ago to an economy reaching upwards of €3 trillion today. A veritable rag to riches transformation. Luxembourg is currently exposed to criticism from Brussels that it has concluded secret treaties with overseas companies for the avoidance of tax payments totalling billions of euros.

The Duchy is also a seat to many Captive insurance companies which find its regulation and tax advantages attractive. Other competing Captive domiciles wonder whether such grey clouds hovering over Luxembourg as a result of scandals perpetrated by group companies have dirtied the waters for future Captive owners aiming to settle there.

This has been refuted by Victor Rod, manager of the insurance supervisory authority of Commissariat aux Assurances saying he is adamant captives will not suffer but admits that bad publicity is not good for the jurisdiction’s image.

Victor reiterates that in his opinion there is nothing irregular taking place among licensed captives. The only sugaring involves use of the famous equalization reserve which is tax deductible from the taxable income, but this is a technical provision and has nothing to do with secret individual tax rulings currently under the scrutiny of Brussels.

Jean-Claude Juncker refutes any responsibility saying that personally he was not involved in any of these tax concessions. Juncker is reeling from the backlash and tries to wipe egg from his face, being recently appointed as President of the EU commission.The alleged conflict of interest is culpable given that he was for many years prime minister and chief finance minister of Luxembourg yet he solemnly promised not to interfere with the report instigated by Margrethe Vestager, the competition commissioner.

Some observe at the European Parliament that in the short term the credibility of Juncker would be damaged, given his proximity as a finance minister to tax concessions approved in Luxembourg on his watch.

It comes as no surprise that ministers for Economic Affairs in Central Europe (themselves suffering under a sluggish economy registering low tax revenues) demand an end to these unique tax rulings in Luxembourg aimed at groups of companies.

They regret that if this loophole persists then such groups of companies can play EU-member states one against the other, putting the project ‘Europe’ in jeopardy.

Yes the meek and soft speaking mandarins at the grand Duchy approved companies like a German Bank, Ikea and Amazon and in the process have woven a web of complicated finance structures with their magic formulas giving birth to a perfectly legal structure that reduces taxes close to one percent.

The result of this probe came like a bolt in the blue when 28,000 confidential documents were scrutinized by the Consortium of Investigative Journalists (ICIJ) in which media located from a diverse  26 countries have affiliated, including heavy weights such as ‘Süddeutsche Zeitung’ from Germany, ‘Le Monde’ from Paris, ‘The Guardian’ from London as well as ‘Asahi Shimbun’ from Japan. This process involved more than 80 journalists – a team that labored daily for a period of six months.

The Guardian newspaper reported that the business consultancy Pricewaterhouse Coopers helped a total of 340 companies to muster approval of concessions from Luxembourg between 2002 and 2010.

Also popular were the use of investment trusts which have been constructed to lower taxes for real estate projects in several European countries. Due to lax regulation the golden rule of “management and control” or substance was circumvented as many of the companies would have maintained only a marginal presence in Luxembourg.

Some opinions in the European Parliament say the credibility of Juncker would be damaged unless he proves that he was not aware of the introduction of the tailor made tax rulings in Luxembourg.

The BBC’s Panorama uncovered documents that positively illustrated how smart companies trimmed their tax liabilities and were able to improve their dividend distributions to shareholders.

GlaxoSmithKline, a top FTSE 100 multinational company had in 2009 established a Luxembourg company. Immediately it loaned mega sums to its parent in UK which in turn paid nearly £124m in interest back to the Luxembourg subsidiary.

The tax loophole was neat – the Luxembourg tax authorities levied a tax on the interest received of just 0.5%, or £300,000 but the parent saved an equal deduction in its books of £34 million as the corporation tax rate was then 28%.

But this was not the only company that dipped its finger in the bottomless jam jar. The report talks of many established UK companies that moved capital through Luxembourg.

Equally interesting was the loss by HMRC when it allowed Vodafone to pay just £1.25bn of an alleged £6bn tax bill from a takeover organized in Luxembourg.

Besides one can mention other companies involved like PepsiCo, FedEx, Procter & Gamble, Amazon and Ikea.

In neighboring Germany the loss of tax revenue is even more pronounced. Very high tax revenues allegedly were leaked to neighboring Luxembourg because of its unique tax model. For example the German Tax Trade Union alleges that according to its own calculations at least ten billion euros in tax slippages were forfeited in Germany.

Quoting its chairperson he lamented to the media ‘the action of the state of Luxembourg is scandalous albeit it is perfectly legal on the strength of its tax code. According to German media entities such as E.on and Fresenius Medical Care created internal loans linked to establishments in Luxembourg.

Subsidiary companies of E.on in other European countries managed successfully to transfer interest payments at low tax rates to Luxembourg, so the profits in the hosted countries decreased and as explained earlier this results in a composite low rate of tax liability.

In conclusion, one hopes that Malta’s own tried and tested tax regime will triumph in the aftermath of such probes to be hailed as a perfect example of fair tax competition.

On the contrary, the discovery by journalists of Luxembourg’s sleight of hand may conjure a scathing report that may haunt the ghost of Juncker during his term as EU president.

Will Margrethe Vestager succeed to weed out the poisoned apple in the tiny Duchy which was the cause of so many millions in tax revenues irretrievably lost by host countries? Only time will tell if she wins the battle against bureaucracy in Brussels which hangs over her head like a Damocles sword.

Anke Boeckmann is a tax researcher at PKF Malta, an audit and business advisory firm.