Leaks Push EU Tax Reform to Fore

OECD’s more measured approach continues to tick along in the background. 

Eighteen months after the Organization for Economic Cooperation and Development issued an action plan to keep companies from arbitraging tax jurisdictions to dodge taxes, a similar but more politically charged effort is gaining steam within the European Union.

Specifically, there have been calls from members of the European Parliament over the past month for investigation into Luxembourg’s deals with Pepsi, IKEA, Procter & Gamble and JP Morgan, along with about 340 others, that allegedly allow these firms to pay very little tax – in some cases, less than 1 percent – on earnings they channel through Luxembourg. Germany, France and Italy took this a step further in the first week of December and publicly criticized Luxembourg for allowing the tax deals to go forward. 

A joint letter from German, Italian and French officials, reported in the Financial Times and Wall Street Journal, said, “Our citizens and our companies expect us to cope with tax avoidance and aggressive tax planning. It is our common duty to meet their expectation by ensuring that everyone pays its fair share of tax to the state where profits are generated.” The letter was signed by Germany’s Wolfgang Schäuble, France’s Michel Sapin and Italy’s Pier Carlo Padoan.

There are calls for investigations into Ireland and the Netherlands’ tax policies as well, which have allegedly helped companies including Amazon, Google and Starbucks to minimize taxes.

The calls for investigations of Luxembourg’s tax policies have put Jean-Claude Juncker, the European Commission president, in a tight spot, since he was previously Luxembourg’s prime minister.  

EU Goes for the Sizzle

The accusations got a dramatic boost in November when the International Consortium of Investigative Journalists reviewed some 28,000 pages of confidential documents and concluded that large companies have channeled hundreds of billions of dollars through Luxembourg and saved billions of dollars in taxes.

The ICIJ said that companies can book big tax savings by creating complicated accounting and legal structures that move profits to low-tax Luxembourg from higher-tax countries where they’re headquartered or do lots of business. The documents included hundred of private tax rulings provided to companies seeking favorable tax treatment.

The EU has been investigating whether the country’s tax deals with Amazon and Fiat Finance violate European law, but have complained that Luxembourg officials have not provided all the documents they require for the investigation.

The leaked documents reviewed by ICIJ involve deals negotiated by PricewaterhouseCoopers. According the ICIJ, PwC tax advisers helped come up with financial strategies that feature loans among sister companies and other moves designed to shift profits from one part of a corporation to another to reduce or eliminate taxable income.

For example, ICIJ said that FedEx set up two Luxembourg affiliates to shuffle earnings from its Mexican, French and Brazilian operations to FedEx affiliates in Hong Kong. Profits moved from Mexico to Luxembourg largely as tax-free dividends. Luxembourg agreed to tax only one quarter of 1 percent of FedEx’s non-dividend income flowing through this arrangement – leaving the remaining 99.75 percent tax-free.

The principal findings of ICIJ’s investigation are as follows: 

• Pepsi, IKEA, AIG, Coach, Deutsche Bank, Abbott Laboratories and nearly 340 other companies have secured secret deals from Luxembourg that allowed many of them to slash their global tax bills.
• PricewaterhouseCoopers has helped multinational companies obtain at least 548 tax rulings in Luxembourg from 2002 to 2010. These legal secret deals feature complex financial structures designed to create drastic tax reductions. The rulings provide written assurance that companies’ tax-saving plans will be viewed favorably by Luxembourg authorities. 
• Companies have channeled hundreds of billions of dollars through Luxembourg and saved billions of dollars in taxes. Some firms have enjoyed effective tax rates of less than 1 percent on the profits they’ve shuffled into Luxembourg.
• Many of the tax deals exploited international tax mismatches that allowed companies to avoid taxes both in Luxembourg and elsewhere through the use of so-called hybrid loans. 
• In many cases Luxembourg subsidiaries handling hundreds of millions of dollars in business maintain little presence and conduct little economic activity in Luxembourg. One popular address – 5, rue Guillaume Kroll – is home to more than 1,600 companies.

OECD Goes for the Steak

The OECD’s efforts to keep companies from gaming corporate taxes in different jurisdictions, called its Action Plan on Base Erosion and Profit Shifting (BEPS), has been making slow but steady progress. Issued and approved at a G-20 summit in July 2013, the BEPS has five basic goals (see iTreasurer August 15, 2013): 

1. Eliminate double non-taxation by harmonizing international tax systems;
2. Use profits to locate intangibles rather than allowing them to be booked in (for example) Ireland;
3. Require a domicile so everyone knows what accounting and financial rules the company must abide by;
4. Disclose accounting practices to allow investors to ferret out tax avoidance schemes; and
5. Create dispute resolution mechanisms for the inevitable cross-border clashes.

The OECD issued a discussion draft in March related to “hybrid mismatch arrangements,” which, it wrote, “can be used to achieve unintended double non-taxation or long-term tax deferral by, for instance, creating two deductions for one borrowing, generating deductions without corresponding income inclusions, or misusing foreign tax credit and participation exemption regimes. Country rules that allow taxpayers to choose the tax treatment of certain domestic and foreign entities could facilitate hybrid mismatches. While it may be difficult to determine which country has in fact lost tax revenue, because the laws of each country involved have been followed, there is a reduction of the overall tax paid by all parties involved as a whole, which harms competition, economic efficiency, transparency and fairness.”

The draft suggests changes to the OECD Model Tax Convention and various domestic law provisions to limit these arrangements and provide disincentives to treaty shopping.

The political drama of the EU MEPs’ investigation may distract the OECD’s efforts, which are more inclusive of business interests and input. However, whatever the OECD eventually cooks up needs to be implemented through individual jurisdictions’ legislatures; having a political scandal simmering behind the scenes might just give supporters of reform the impetus they need to push the legislation through.