Luxembourg set for a “huge change”

Governments around the world want more tax income. There is a widely held feeling that many international companies are basing themselves in places like Luxembourg, Ireland, and the Netherlands to avoid tax. The world’s largest countries have a plan and things will change.

What will be the effect on Luxembourg, and will it have the desired outcome?

“I’m optimistic,” Finance Minister Pierre Gramegna said at the March 3 AMCHAM seminar “Luxembourg’s Position in a New Tax World”.

On the face of it, the action to hit international firms would appear to threaten places like Luxembourg. However, the evidence so far suggests this country is actually set to benefit.

Delaying, not avoiding

International businesses use places like Luxembourg to delay paying tax. Deals are struck with the tax authorities to limit the amount of tax paid on profits. Firms are then able to spend this money later on things like new investment or dividends. This spending is then taxed.

Until now, firms didn’t need to do much to be based in Luxembourg. They mainly organised an official address without actually employing anyone here, hence the term “letterbox company”.

This still allowed them to make tax agreements which helped them delay paying tax. International action* will change this.

People will need to move

The new rules will require “flesh and blood, decisions being made here, daily work,” noted Louis Thomas of the consultancy KPMG, who spoke at the event.

Firms will have to show genuine presence wherever they have their tax base, with key businesses decisions and operations located here, and senior managers and other staff living locally.

This is actually happening already. International firms are beefing up their Luxembourg operations and hiring new staff. Much of this explains why housing prices are rocketing and a near record amount of office space is being built.

“Letterbox companies will become increasingly rare,” noted Mr Gramegna, “the game now is about adding substance. We will lose many firms, but if we can keep a reasonable number we will be okay,” adding: “People were worried when we abolished banking secrecy, but now we see that although the number of clients are down, we have attracted more high net worth individuals.”

There are concerns that some in the EU want to go beyond the international agreements in an attempt to squeeze more tax out of the economy. However, Mr Gramegna is confident that Luxembourg has several allies in this matter, and that the letter and spirit of these deals will be followed when EU law comes to be written.

An effective move?

It remains to be seen whether these moves will reap more tax income for countries around the world.

If so, it will be consumers who will pay much of this. After all, companies only make profits from the products they sell. Prices might have to rise to compensate for the added cost of complying with new rules and paying new taxes.

Affordable tax reform?

In a post-speech Q&A, Mr Gramegna was asked about the February 29 tax reform announcement. Corporate tax is due to be cut, but business leaders have said this might be insufficient to compete successfully with other European countries. Mr Gramegna spoke of these changes being a “start”.

He was also asked to comment on the wisdom of the announced tax giveaway in terms of balancing the budget. “We can do it because we cut spending earlier and the economy is doing better than we anticipated,” he said.

A big reason why the economy is purring is the arrival in force of so many international businesses.

*The “base erosion and profit shifting” (BEPS) project is the main tool for change. This will be enacted in Europe through an EU directive.