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 The rule, which dates back to World War Two, helps companies save
hundreds of millions of dollars in taxes each year, a Reuters
analysis of the accounts of several major international corporations
shows. The profits that escape tax have often not been earned in
Luxembourg, but in countries like Britain, the United States and
Germany. Those countries may lose out.
New York-listed telecoms group Vimpelcom, U.S. internet group AOL
Inc., building equipment maker Caterpillar and UK mobile telecoms
group Vodafone are just four of those to have made use of the
system, accounts for their Luxembourg subsidiaries show. Other firms
have similar arrangements, tax advisers say, but have not made them
public.
What these firms can do that companies in most other countries
cannot is use notional losses — like a fall in the value of an asset
that a business still holds — to cut their corporate income tax. In
other countries, such an asset would have to be sold, so that the
loss is realized, before the company could use it to reduce its tax
bill. The only other country to offer a similar tax break is
Switzerland, according to 20 tax advisers from a dozen countries
interviewed by Reuters; but they said the Swiss are more
restrictive.
In the European Union, where some countries use tax incentives to
attract corporate investment, Luxembourg's rule is a unique lure.
Tax advisers say it has helped attract more than 40,000 holding
companies and thousands of high-paying jobs for the population of
nearly half a million.
"For a government that wants to collect taxes ... this is just a
stupid idea," said Reimar Pinkernell, tax partner in Flick Gocke
Schaumburg in Bonn. "But if you don't want to collect taxes, if you
are just happy that the company is there, and employs some people,
then this is a perfect system."
The leaders of the Group of 20 biggest economies pledged in
September to close some international loopholes in company tax, but
their plans won't target country-specific practices like
Luxembourg's. EU sources said in September the European Commission,
the executive arm of the EU, wrote to Luxembourg, Ireland and the
Netherlands asking for details of tax deals they had cut with
foreign companies, to see if they meet competition rules.
Tax advisers point out that other countries offer different tax
breaks to attract investment. The Luxembourg Ministry of Finance
said its tax rules are sensible, and not intended to help companies
shift profits from other countries.
"A lot of countries use tax competition," said Heather Self, partner
at law firm Pinsent Masons in London. "There's nothing wrong with it
and there's nothing wrong with companies taking account of different
tax rates. Tax is just another cost of business."
Spokespeople for the U.S., UK, French and German finance ministries
declined to comment or said it would be inappropriate to comment on
another country's tax rules. A spokesman for the EU Commission said
the issue was not one it has examined in detail.
AN "INTERNAL BANK"
Here's how the rule works. If a company makes an investment, say it
buys another firm, and the business turns out to be worth less than
it paid, the company will follow international accounting rules to
reduce, or write down, the value of the asset in its accounts. In
countries like Britain and the United States, that impairment does
not generate a tax saving. But in Luxembourg it does.
The case of Dutch-based Vimpelcom Ltd, one of the biggest phone
operators in Russia with operations in Canada, Italy and North
Africa, shows how firms can benefit.
At the end of 2012 a Vimpelcom subsidiary, a holding company called
Weather Capital Sarl, made a 1.1 billion-euro ($1.51 billion)
write-down in relation to some shares it held in a subsidiary,
Weather Capital Special Purpose 1 Sarl, also a holding company. It
also reported an 840-million euro decline in the value of a loan it
had made to the holding company.
Under Luxembourg rules, those two losses could save hundreds of
millions in tax.
But the loss doesn't give a saving on its own: It must be offset
against profits. And Luxembourg's domestic market is too small to
make much profit; Vimpelcom doesn't even have a telephone business
there.
So the company found another way to benefit.
In January this year, it told investors at a presentation in London
that it planned to establish an "internal bank" that would borrow
money and lend it on to operating units around the world, to fund
their investments.
Henk van Dalen, its Chief Financial Officer at the time, said the
company planned to route $13 billion to $15 billion of loans each
year through the new financing unit. The in-house bank would
generate large profits by charging more in interest than it had to
pay. And these profits would escape tax because the financing
operation would be based in Luxembourg, where Vimpelcom had big tax
losses to use.
The "tax saving" would be $200 million to $250 million each year,
van Dalen said.
Vimpelcom declined to comment or answer questions about its
Luxembourg operations. Van Dalen did not respond to requests for
comment.
It could go on indefinitely, van Dalen told the London meeting, a
video of which is available on the company website. "Of course, at a
certain moment you will run out of these tax losses and then there
will be a new phase developed for the financing company," van Dalen
said.
One investor on the video described the structure as "fairly
ingenious."
But University of Connecticut School of Law Professor Richard Pomp
said the system made no sense. "It's absurd," he told Reuters of the
Luxembourg rule. "It gives the taxpayer too much control in managing
their tax bill."
AOL'S LUXEMBOURG MOVE
Luxembourg's practice was actually inherited from Germany and dates
back to the occupation of the Grand Duchy during the Second World
War, said Ministry of Finance spokeswoman Veronique Piquard.
Indeed, Germany allowed companies to create such tax losses until
2001, although Berlin was less generous, German tax lawyers say.
Another difference was that while Germany gave deductions for
write-downs, if a firm made a profit when it sold an investment, the
company would be taxed on that.
In Luxembourg, if the investment goes up in value or is sold at a
profit, the gain isn't taxable. Pomp, the University of Connecticut
professor, calls that a "one way bet" for companies. "There should
be symmetrical treatment," he said. "This is a pure tax incentive."
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Tax advisers say Germany changed its approach because it stopped
taxing capital gains, so it no longer made sense to give a deduction
for losses. Piquard said Luxembourg's treatment of write-downs was
not a tax incentive and the tax authority only gave deductions for
write-downs which were justified.
The deductions can be quite quickly arranged, as illustrated by the
case of internet group AOL Inc.
AOL told investors in its 2009 annual report that it was
experiencing weakness in its European display advertising business.
In 2010, it transferred ownership of several European advertising
subsidiaries from a British to a Luxembourg-based company.
Months later, that company, AOL Europe Sarl, wrote down the value of
the advertising units as part of a 27-million-euro impairment. It
then offset this against royalty income totaling 6 million euros,
which could otherwise have incurred tax of almost 2 million euros.
Had AOL left the units with the British holding company and taken
the losses there, it would not have received any tax benefit.
Piquard declined to comment on individual companies' tax affairs.
AOL also declined to comment.
CATERPILLAR'S CONSOLATION
Boosting the appeal of Luxembourg's rule is the fact that many
takeovers — more than half, according to some studies — don't work
out for the acquirer.
Take Caterpillar, which shocked investors in January by writing down
almost all of the value of ERA Mining Machinery Ltd., a Chinese
company it agreed to buy for more than $653 million in 2011.
Caterpillar cited alleged accounting irregularities at an ERA
subsidiary, and the write-down wiped out more than half its earnings
for the fourth quarter of 2012.
However, there was some consolation for Caterpillar investors,
because the deal was structured through a Luxembourg holding
company.
The write-down generated a tax deduction of $445 million that could
be used to offset Caterpillar's future income in Luxembourg.
Caterpillar declined to comment.
VODAFONE'S PROFITS POWERHOUSE
One of the most successful users of the Luxembourg rule is Vodafone.
The losses it built up in Luxembourg are so big the Grand Duchy's
approach to taxing write-downs has helped it save billions of euros
in taxes over the past 13 years.
Vodafone became the largest mobile phone company in the world after
a buying spree in the late 1990s, with deals such as the $180
billion takeover of Germany's Mannesmann AG. After the tech bubble
burst, Vodafone had to write down these assets.
They were held in Luxembourg, which meant that the 70 billion euros
in charges it reported could be used to offset future profits.
These have been significant. Since Vodafone's first write-downs in
the year to March 2002, just four Vodafone Luxembourg subsidiaries
have earned almost 30 billion euros.
Two have been like Vimpelcom's "internal bank". Vodafone Luxembourg
5 Sarl (VL5), made $15 billion in profits from lending to the
group's U.S. arm, while Vodafone Investments Luxembourg Sarl (VIL)
made 18 billion euros lending to affiliates such as Vodafone's
German arm. Interest payments are tax deductible in the United
States and Germany, so the U.S. and German units' taxable income,
which could have exceeded 60 billion euros, was also reduced by this
arrangement.
More recently, two other Vodafone subsidiaries have gone beyond
lending, to start business operations in Luxembourg. The firms — Vodafone Procurement Company Sarl (VPC) and Vodafone Roaming
Services Sarl (VRS) — trade phone equipment and telephone bandwidth
between affiliates and external suppliers. Their 300 staff generated
an average 1.7 million euros per head in profit in the year to March
2013, compared with a group average of around 44,000 euros per
worker.
Combined, these arrangements mean Vodafone reports more profit in
Luxembourg than it does in any other country apart from the United
States, group accounts show.
And thanks to the tax losses it has built up in Luxembourg, it has
paid only around 100 million euros in tax since 2001. If Vodafone
had paid the headline tax rate on this profit, it would have faced a
bill of almost 9 billion euros.
Vodafone said it did not use contrived arrangements to shift
profits. "Vodafone acts with integrity in all tax matters and
operates under a policy of full transparency with the tax
authorities in every country in which we operate," the company said
in a statement.
Head of Group Media Relations Ben Padovan said the profits reported
in Luxembourg reflected genuine economic activity there and the
arrangements had no impact on Vodafone's UK tax bill.
Vodafone added that the decision to hold its investments and base
its inter-company financing in Luxembourg reflected a variety of
factors including the country's location within the euro zone, "the
stability and predictability of the tax, regulatory, social and
political environment and the availability of relevant skills within
the labor market."
If companies do use Luxembourg's rules to avoid taxes in other
countries, said Luxembourg tax lawyer Thierry Lesage, then it was up
to other countries to change their systems.
The system is "really part of the DNA of the Luxembourg holding
(company) taxation system," he said. "As a sovereign state
Luxembourg is allowed to determine its fiscal policy."
($1 = 0.7283 euros)
(Edited by Sara Ledwith and William Waterman)
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