The Lure of Europe’s Tax Havens

The 2008 financial crisis not only changed the shape and size of the global economy—combined productivity and employment shrank by 5.5 percent in 2014 across OECD countries—it also redefined how leaders across the world discuss and describe finance, banking, and wealth. According to Angel Gurria, Secretary-General of the OECD, it became “politically intolerable,” after billions in taxpayer money were used to bail out the world’s largest banks and corporations, that “only the middle classes and small- and medium-sized enterprises pay taxes while high net-worth individuals and multinationals don’t pay any at all.” In 2009, leaders of the G–20, at the now-infamous Pittsburgh Summit, acknowledged that it was time “to turn the page on an era of irresponsibility” in global taxation and vowed to “take action against non-cooperative jurisdictions, including tax havens.” As the group announced later that year, “the era of banking secrecy [was] over.”

The same cannot be said of corporate tax avoidance and evasion. Although the United States’ Foreign Account Tax Compliance Act in 2010, which required foreign banks to report the overseas assets of U.S. citizens, may have signaled the beginning of the end to anonymous banking schemes, a number of scandals, including the Luxembourg Leaks in 2014 and the Panama Papers two years later, have continued to expose how the world’s wealthiest exploit shortcomings in corporate tax rules in order to shift money across the world and hide cash from tax authorities.

Those leaks have spurred on countries in Europe, in particular, to pick up the pace on corporate tax reforms. They include sanctions on a blacklist of offshore tax havens with overly “preferential tax regimes,” a rule set to come into force at the end of 2017, and a more radical proposal now under consideration known as a “common consolidated corporate tax base” or CCCTB. This would create a EU-wide tax regime designed to eliminate profit shifting, which corporations like Google and Apple use to avoid paying taxes in Europe by transferring their profits to low-tax jurisdictions such as Ireland and Luxembourg. 

In spite of the recent progress, however, the momentum in Europe for fair corporate taxation is facing new resistance. On April 8, Europe’s 28 finance ministers flew to the island of Malta to discuss “better tax certainty,” business speak for putting the breaks on tax reform. In a paper prepared by the Maltese hosts, and which I reviewed, Europe’s finance ministers were called upon to support only “gradual changes” in Europe’s tax regimes and to avoid new regulations that were “radical and disruptive.”

To some lawmakers, this call for more efficient and certain taxation immediately raised a red flag. “The Maltese are attempting to launch an offensive that will change the EU’s discourse around tax,” said Sven Giegold, a European lawmaker who sits on the Economic and Monetary Affairs Committee of the European Parliament. “It’s clear that a lot of corporates are unhappy with the changing international climate around tax, and Malta is looking out to protect its business model as a tax haven for large corporations.” 

An EU official present at the talks in Malta, and who requested anonymity because of the confidentiality of the meeting, said that there was a feeling from some countries that calls for tax certainty could clash with the progress of recent European tax reforms. “The German delegation pointed out that perfect tax certainty was simply impossible to offer to companies,” he said. “Above and beyond this, it warned that any support of tax certainty for businesses cannot be a smokescreen distraction for unfair tax practices to continue.”

LOOPHOLES APLENTY

In Europe, coordinating fair corporate tax policies has long proven challenging since several EU member states—such as Belgium, Luxembourg, and the Netherlands—are themselves tax havens. These countries net hundreds of millions in tax revenue each year by promising competitively low corporate taxes at the expense of other jurisdictions in Europe where corporate tax rates are higher.

Malta, another tax haven, is notorious for being a purely administrative base of operations for multinational corporations that benefit from the country’s accommodative tax code. In a report commissioned by the European Parliament, Tommaso Faccio, Lecturer in Accounting and Taxation at Nottingham University Business School, estimated that Malta netted an estimated $262 million in 2015 in tax revenue from multinationals who have established an administrative subsidiary in the country. However, the amount of tax credit that it granted that year totals around $4.6 billion, meaning $4.6 billion in lost tax revenues for other governments across Europe and across the world. 

Although Europe has implemented a long list of OECD-proposed reforms aimed at outlawing these profit shifting techniques, the fear remains that these reforms are dotted with loopholes. In taxing corporate subsidiaries in countries like Malta, the EU’s Anti-Tax Avoidance Directive, adopted in 2016, only calls for taxing profits that have been shifted into a low-tax jurisdiction if the company’s tax burden in that jurisdiction is less than 40 percent of what it would be in the parent company’s jurisdiction. For example, if a company were headquartered in Bulgaria, where the corporate tax rate is ten percent, and then shifted its profits to a subsidiary in another European country, the company would only pay Bulgarian taxes on its subsidiary’s profits if they were taxed under four percent (which is 40 percent of ten percent). 

According to critics like Giegold, this threshold is too low to recoup lost tax revenue and encourages the lowering of corporate tax rates to attract multinational corporations. “The 40 percent scheme provides an incentive for EU Member States to reduce their own tax rates in order to circumvent the taxation of the profits of the subsidiary in the third country,” he said. 

The most obvious cure-all for Europe’s patched network of tax havens is the implementation of the CCCTB. This tax regime would apportion the size of a company’s tax burden according to its real economic activity in a jurisdiction (meaning, the value of its tangible assets, workforce, and sales in a given country). So-called letterbox jurisdictions such as Luxembourg and Malta, where recorded profits far surpass the actual level of economic activity in those countries, would stand to lose the most from the CCCTB. 

PUTTING THE BRAKES ON REFORM 

That is why ambitious reforms like the CCCTB face a number of uphill battles, including homegrown resistance from tax havens such as Malta, particularly as it now chairs the influential presidency of the European Council. That role gives the country a fair degree of influence over the direction of European law in 2017, and some lawmakers in Brussels have said that the Maltese presidency presents an inevitable conflict of interest when it comes to passing anti-money laundering rules and the CCCTB. Malta, meanwhile, has rejected those claims, asserting that its “unique” corporate tax system is entirely compliant with the spirit and the letter of European tax laws. It has also defended its track record in passing through and implementing tax-related dossiers since it took over the European Council’s presidency in January.

At the April meeting in Malta, its chair, Maltese Finance Minister Edward Scicluna, insisted in his closing remarks that the informal gathering did not represent a “slowdown” in the European Union’s support for stricter tax rules. But he also stressed that it was time for realism in reaction to the threat of competitive corporate tax cuts in the United Kingdom, for example. British Prime Minister Theresa May has suggested cutting corporate tax rates to ten percent—which would make it the lowest in the G–20—in order to attract business once Brexit negotiations are finalized. Those cuts could leave European nations at a competitive disadvantage if they press forward too quickly on ambitious corporate tax reform, he argued. Within the closed-door meeting at Malta, a chorus of voices led by Luxembourg fervently agreed.

At this time, EU ministers seem prepared to move into a holding pattern as they await what comes after Brexit negotiations are finalized over the next two years and whether U.S. President Donald Trump will deliver on his promised tax reforms. Fair tax campaigners,  however, argue that such a pause would simply maintain the status quo to the benefit of the world’s wealthiest. “When governments lose tax revenues,” Oxfam wrote in a recent report, “ordinary citizens pay the price: schools and hospitals lose funding and vital public services are cut. At the same time, increased profits as a result of lower corporate taxation benefit wealthy company’s shareholders, only further increasing the gap between the rich and poor.”

With populism and euroskepticism growing across the continent, just as crucial elections in France and Germany approach, maintaining the status quo on tax reform only enhances the EU’s reputation as elitist and out-of-touch. Its leader, Jean-Claude Juncker, was responsible for the design of Luxembourg’s notoriously accommodative tax haven schemes, and cables leaked earlier this year revealed how he had a role in holding up coordinated European tax reform while he served as Luxembourg’s prime minister. This, alongside “business as usual” for corporate tax reform, will only further fuel suspicions that the European project is dysfunctional and subservient to the will of the world economy—a system fatally rigged to benefit those at the top.