TAX: The friendly state

The funds industry in Luxembourg pays €1 billion a year in tax – a tenth of the country’s fiscal take. But critics claim the Grand Duchy been colonised by a financial elite. David Stevenson reports on the unfolding tax controversy.

The so-called ‘LuxLeaks’ affair brought Luxembourg’s alleged status as a tax haven to prominence again in 2014. 

The scandal erupted when a former PwC employee released a list of companies that had hired the accountancy firm with a view to reducing their tax bills using Luxembourg vehicles. The roll call of hundreds included asset managers such as Pimco and Schroders – but in Luxembourg’s funds industry, there’s bemusement over why the jurisdiction is being singled out.

“I’m bored of, and used to, hearing about Luxembourg and tax, as success breeds jealousy and detractors. It’s one thing we have to live with. It makes us more determined,” says Camille Thommes, director general of the Association of the Luxembourg Funds Industry (Alfi).

Richard Murphy, founder of the Tax Justice Network pressure group, sees things differently. He says the reason funds are domiciled in such a small jurisdiction is its ability to pass business-friendly laws.

“Luxembourg has been captured by the financial services industry, which is now effectively running the place to its own advantage. They wanted to make sure no tax is paid on monies flowing through Luxembourg. That’s the nature of fund management,” he adds.

This is not the case, according to Thommes, who says funds are subject to a subscription tax levied on their assets. Rates vary from one to five basis points. Annually, the industry generates €1 billion in taxation – roughly 10% of the entire fiscal take. As Thommes observes, most other countries don’t apply any tax at a fund level. He concedes, though, that Luxembourg has a government receptive to the needs of the funds industry and committed to supporting it. 

In the wake of the LuxLeaks scandal, the UK’s Public Accounts Committee took PwC to task. Margaret Hodge, who chairs the parliamentary body, accused the accountancy firm of promoting tax avoidance in Luxembourg “on an industrial scale”. But there was no accusation of any legal wrongdoing; Luxembourg is simply using its beneficial tax regime to attract businesses.

For its part, the funds industry has sought to distance itself from the controversy over Luxembourg’s reputation. 

“Tax [avoidance] is not related to the funds industry, it’s tax-neutral. We offer no more, or less, advantages than any other fund jurisdiction,” says François Pfister, managing partner of law firm Ogier in Luxembourg.

Others in Luxembourg echo the sentiment. Laurent Fessmann, a funds partner at international law firm Baker & McKenzie, says: “The tax debate is a complete misconception. All fund investors are tax-exempt.” 

But for Murphy, some of the arguments don’t ring true. “Tax neutrality is a weasel word. It means, in their terminology, no tax. Neutral equals zero – that is why they are there. All tax havens say the same thing: ‘We’re tax neutral.’ This argument of tax neutrality is a load of nonsense, as double taxation is going back to the dimmest past.”

Thommes at Alfi credits Luxembourg’s success as a funds jurisdiction to a stable political, economic and social environment, recognised by Fitch’s AAA rating.

Keith O’Donnell, managing partner of tax specialists Atoz, believes that the stable economy is a great selling point. He says Luxembourg is financially well managed, with relatively little debt – 25% to GDP being very low by European standards – and that unlike some of its neighbours, its economy didn’t shrink during the global financial crisis.

José Ignacio Pascual Gutiérrez, a partner at the newly opened Luxembourg office of law firm Simmons & Simmons, cites the country’s stable legal framework and good tax system. It’s a system that goes back a long way. 

In 1929, Luxembourg passed the Holding Company Act, rendering holding companies tax-exempt. This was phased out in 2011, but a new set of beneficial tax laws were introduced, such as Société de gestion de patrimoine familial (SPV). The SPV, which had the same tax exemptions as the 1929 act, is more clearly defined as only serving private investors and narrows, to some extent, the definition of passive investments.

In response to those who slate Luxembourg’s tax system, O’Donnell says LuxLeaks demonstrates nothing but the application of the law. If it is too aggressively pro-business in respect of tax avoidance, the EC can intervene. “We have a tax environment which is favourable, but not against the rules,” he says.

Luxembourg has faced the wrath of the European Court of Justice before over its tax regime, however. In 2003, the country was found to be in contravention of the EU’s Savings Tax Directive regarding the status of beneficial owners. Other parts of the tax code also benefit the funds industry. Fund administration, investment management and risk management are all exempt from VAT under Luxembourg law. Even services outsourced by a fund management company to a third-party manager should be covered by the exemption. These exemptions are applicable to both regulated funds, such as Ucits, and to alternative investment funds.

Luxembourg’s tax and regulatory framework for alternative investment funds is extremely attractive, using both the Sif (fonds d’investissement spécialisé) and the Sicar (société d’investissement en capital à risque) regimes. As Gutiérrez says, some investors prefer opaque tax structures, while others like transparent ones. A Sif may be organised as a tax-opaque company in one of the various forms available in Luxembourg, or as a tax-transparent partnership or contractual arrangement managed by a Luxembourg management company. The choice of which structure to use will usually depend on the investor’s country of origin. 

While many European countries have certain attractive tax rules – for instance, participation exemption that nullifies the taxation of shareholder dividends and capital gains – Luxembourg has this and a whole lot more. 

“Fundamentally, Luxembourg has an effective participation exemption,” says Murphy. “The Netherlands also has it, but not a load of other things like secretive holding company arrangements. They don’t have the co-operative funds management laws, they don’t have a tax authority that is willing to look favourably on many tax arrangements.”

While those in the funds industry will argue that tax is not a factor in making Luxembourg a hub for the industry, there is evidence that the legislature has been extremely co-operative when drawing up its tax code. 

As Pfister says: “The political brains and the economic brains do speak to each other [in Luxembourg]. Two calls and you get an appointment with the minister. The decision-making time is very short. There’s an alignment with the political and economic factions, so it makes it easier to manage the country.”

Some may be wary of such a cosy relationship between business and government, but those in the funds industry say that this relationship in Luxembourg does not simply amount to providing a low-tax environment. 

Thommes says Alfi enjoys a continuous dialogue with the political authorities, who provide a suitable legal environment to host certain types of funds. He points to the introduction of a limited partnership regime, designed to enhance the attractiveness of Luxembourg to alternative funds. 

Taxation may play a part in Luxembourg’s success as a funds jurisdiction, but it is part of a wider toolkit used to benefit the largest employment sector in the country: financial services.

©2015 funds europe



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