Tax Analysts Blog

The Ghost of Captain Renault

Posted on Nov 14, 2014

"I am shocked, shocked to find there is gambling going on in here!"

Thus spoke Captain Louis Renault moments before receiving his roulette winnings in Casablanca. Throughout the film, Renault straddles the blurred lines between rational self-interest, nationalistic loyalty, and institutionalized corruption. Ultimately he does right by Humphrey Bogart's character, the film's protagonist, but let's face it -- adherence to transparent governance isn't Renault's thing. For many, the fictionalized portrayal also serves as our lasting impression of the short-lived Vichy regime.

European Commission President Jean-Claude Juncker unintentionally echoed the spirit of Captain Renault this week. The occasion was Juncker's appearance before the European Parliament to address the unfolding “Lux leaks” scandal. It was not his finest hour.

What? There's corporate tax avoidance going on in Luxembourg? You don't say?

In case you missed it, Lux leaks involves a trove of PwC internal tax documents that fell into the hands of the International Consortium of Investigative Journalists (ICIJ). The source for the documents was allegedly a former employee from PwC's Luxembourg tax office. The ICIJ spent months deciphering the documents to learn precisely how large multinational corporations secured massive tax savings through shell companies in Luxembourg.

On November 5 the ICIJ finally went public with the results of its probe, presented in the form of a searchable online database. It's the type of disclosure that would make Julian Assange green with envy. There for all to see were the gory details of how 343 companies finessed their tax liability through secret backroom dealings. The corporate actors include such well-known names as Amazon, AIG, Apple, Burberry, Cargill, Deutsche Bank, FedEx, GE, Heinz, HSBC, IKEA, Pepsi, Verizon, Vodafone, and many more.

Juncker, meanwhile, is only two weeks into his new job as boss of the European Commission. Previously, he spent 18 years as Luxembourg's prime minister. For much of that time he also served as the nation's finance minister. His fingerprints are all over Luxembourg's historic rise to prominence as a favored host nation for tax-efficient intermediary structures.

At first glance, Luxembourg might not look like a tax haven. Its statutory corporate rate is relatively high at 29 percent. Personal income taxes are high as well. And since it’s Europe, there's a VAT. Yet the ICIJ disclosure confirms that foreign firms have been able to push their effective tax rates down to 1 percent (or less) by obtaining preferential advance rulings from Luxembourg's tax agency.

So let's cut to the chase: Anybody who has followed international taxation in the past decade should know perfectly well that Luxembourg is a popular host country for holding companies. So are its neighbors, Belgium and the Netherlands. The three nations actively compete against one other to see which can boast about having the most business-friendly tax environment. It's been that way for years.

With little in the way of “real” economic activity (payroll, sales, manufacturing, etc.), multinational firms are free to use holding companies as a means to shift money back and forth from one affiliate to the next. That's how holding companies function. That's what they do. Money comes in one end and goes out the other. The transfers may take the form of interest, royalties, or dividends as the firms' tax directors see fit. Holding companies are not themselves scandalous.

My objection is not that firms are engaging in aggressive tax planning. As long as companies comply with applicable law to reduce their effective tax burden, who am I to judge? What I strongly object to is the process by which these favorable rulings were issued. Transparency, you see, is near and dear to our heart at Tax Analysts.

Until the Lux leaks scandal, these rulings were strictly confidential. That makes them quite different from the private letter rulings regularly issued in this country by the IRS. PLRs were also secretive at one time -- until Tax Analysts litigated the issue and ultimately prevailed before the courts. The American taxpaying public (and that includes the tax bar) is infinitely better off today because PLRs are disclosed to the public. Where transparency is lacking, corruption will surely follow. Hence our mantra —no secret law.

So when members of the European Parliament responded to Juncker's flimsy defense with a loud chorus of disapproval, including shouts for him to resign, I suspect their fury was aimed less at the low tax rates on offer in Luxembourg during his tenure and more at the process he cultivated.

And one final thought. The IRS still operates a secretive process whereby multinationals can negotiate bespoke transfer pricing outcomes. They are called advance pricing agreements, and they have never been publicly disclosed since the program's inception in the early 1990s. Once they’ve finished busting on Luxembourg, maybe the good folks at the ICIJ can try to crack that nut. Tax Analysts has already tried, but that's a story for another day.

Read Comments (1)

charles chongoNov 15, 2014

This is much to do about nothing.... The ruling process in Lux, as in all
other countries where a ruling is to be obtained...is a pretty cookie cutter
well trodden path. There are standard international tax plays and that is the
focus of the rulings. Simply because there is no disclosure, does not mean
that the bulk or substance of the majority of the rulings is not common
knowledge within the international tax community. There is absolutely nothing
wrong in arranging one's affairs to minimize one's taxes...as long as there is
business purpose and appropriate economic substance...

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