They paid this much ...

Ireland Gets Lucky With Luxembourg's Tax Scandal

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.
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The European Commission's new president, Jean-Claude Juncker, will preside over an investigation of shady tax deals with global companies made by Luxembourg under Prime Minister ... Jean-Claude Juncker. That must be great news for the multinationals -- and for Ireland, which made similar but somewhat sloppier deals of its own. If Luxembourg escapes punishment and Ireland doesn't, the optics will be terrible.

The nonprofit International Consortium of Investigative Journalists has turned the spotlight on Luxembourg's tax rulings, agreements between the country's authorities and global corporations that set out how the latter were to be taxed. The expose is based on leaked documents of more than 340 companies, whose Luxembourg tax arrangements were handled by PricewaterhouseCoopers.

Exploring the ICIJ database is a big job that the journalists themselves do not appear to have finished yet. They pointed out Pepsi's scheme for reducing taxes on a major acquisition in Russia; U.S. luxury goods maker Coach's game of internal loans that allowed it to pay less than 1 percent on profits channeled into Luxembourg; even the tax-reducing prowess of Canada's Public Sector Pension Investment Board, which bought some Berlin real estate from a Luxembourg base. There's more fascinating stuff out there, though.

Just a cursory look through the database yielded a 2010 Verizon scheme for dressing up payouts as share-premium reductions, and a mind-blowing 2011 tax return for iTunes s.a.r.l., the company that collects the Apple content store's European revenues. Globally, Apple had $9.37 billion in revenue from the iTunes/Software/Services segment; the European profit center of the operation reported a tax base of just 90 million euros ($116 million at the end of 2011) and paid less than 26 million euros in taxes on it.

I was particularly interested in Apple because it is at the center of a European Commission investigation of Ireland. In that country, the iPhone maker apparently agreed with the authorities on a more or less arbitrary tax rate, and the negotiations are well-documented. The Luxembourg deals look more solid by comparison because they contain legal arguments and make use of specific exemptions, such as the 80 percent write-off for royalty income from intellectual property, introduced under Juncker.

Here's how Apple's taxable profits were discussed in Ireland, according to a European Commission presentation to the Irish government:

[The representative of Irish Revenue] asked [the tax advisor's employee representing Apple] to state if was there any basis for the figure of $30-40m and he confessed that there was no scientific basis for the figure. However the figure was of such magnitude that he hoped it would be seen to be a bona-fide proposal.

Here's a sample of how PwC framed its arguments in Luxembourg (from the Verizon ruling):

In accordance with the provisions of Article 97 (3) b), any future share capital / share premium repayments will be exempt from Luxembourg withholding tax to the extent LuxCo 2 does not have any retained earnings from previous years (or capitalized reserves) available for distribution at the time of such repayment.

Apple's Irish arrangement has the look of a sweetheart deal, while the Luxembourg documents seem like the workings of a well-oiled tax competition machine. That is an important distinction. The only way the European Union can nail countries and corporations engaging in such tax reduction is through its rules against state aid. That means proving that some companies are given unfair advantages over others. Luxembourg's rulings appear impartial, which allows the country's officials, former and current, to say there is nothing illegal about them. That's what Juncker has said on many occasions, too.

The ICIJ investigators sarcastically quote his July remark: "We will try to put some ethics, some morality into the European tax landscape." That's where their quote ends, but Juncker, in fact, continued: "so that we the governments do not become the victims of tax competition, which is sometimes unfair.”

Clearly, Juncker has nothing against tax competition as such. It would be strange if he objected to it on principle: His country's reputation as a fierce competitor was forged during his 18-year tenure as prime minister.

The ICIJ has provided plenty of juicy detail on how the Luxembourg schemes work, but in principle, their existence was not much of a secret. Back in 2011, a French reporter found iTunes's headquarters in the Grand Duchy and discovered that it was populated by quiet people who were afraid to answer questions or put a sign on the door. Two years ago, French TV producer Edouard Perrin did some highly visible work on corporate tax optimization, with Luxembourg as the focus. It's not that we now know something we were unaware of before. It is, however, important that Luxembourg is now under as much scrutiny as Ireland.

Juncker is quoted in the ICIJ story as promising he would not abuse his position by seeking exceptional treatment for Luxembourg. That is an ambiguous commitment from a wily veteran politician: Juncker did not say he would not seek leniency for Ireland. Even if the island nation got a bit carried away in trying to attract investment from multinationals, fining it and the beneficiaries of its policies will be hard to explain to the public if Luxembourg doesn't share the punishment.

Multinationals and governments involved in tax competition should have little to fear from European bureaucrats. All they need to do is keep updating their schemes and make sure they are applied equitably.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Leonid Bershidsky at lbershidsky@bloomberg.net

To contact the editor on this story:
Toby Harshaw at tharshaw@bloomberg.net