Insight: The Luxembourg tax break that helps firms profit from loss

Tue Dec 17, 2013 5:32am EST
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By Tom Bergin

LONDON (Reuters) - "Life in Luxembourg is simply different," says its government website. The same could be said of tax in the Grand Duchy. It's known for its generous tax policies, but what's less familiar is a Luxembourg rule that lets companies cut their income taxes using costs that they haven't actually borne - a break offered by almost no other state.

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.   Continued...

The Petrusse river is seen in the general view of the city of Luxembourg in this November 20, 2012 file photo. REUTERS/Francois Lenoir/Files