“Why Luxembourg is still a tax haven” was the headline in Monday’s Luxemburger Wort, the country’s leading daily. The evidence for this statement was a report from the EU Tax Observatory think tank which identified the Grand Duchy and 16 other jurisdictions as helping multinational banks dodge taxes.
The report “Have European Banks Left Tax Havens?” sought to calculate the effective tax rates paid by 36 systemically important international banks with their headquarters in Europe. Using publicly available country-by-country data on activities since 2015 they traced the level and evolution of profits booked by these banks in different financial jurisdictions. With this information they calculated a “tax deficit” between the effect tax rates charged in “tax havens” and higher figures being discussed through the OECD and elsewhere.
Defining tax haven status
The researchers at the EU Tax Observatory (which is located of the Paris School of Economics and receives funding from the EU) first set out to establish criteria for judging tax haven status. They used the ratio between staffing levels and profits booked in each jurisdiction, with the implication that if relatively few staff generate relatively high profits this would be largely due to profits being shifted to low tax jurisdictions. They then calculated effective tax rates, that is the actual taxes paid by companies as a share of their profits rather than the headline rates set by governments.
They calculated that Luxembourg levies an effective tax rate of 15% on banks, and pointed to a relatively high profits-to-employees ratio, although they did not define this for the Grand Duchy. They then took this as the upper benchmark below which they would classify countries as tax havens. Bahamas, Bermuda, the British Virgin Islands, Cayman Islands, Guernsey, Gibraltar, Hong Kong, Ireland, Isle of Man, Jersey, Kuwait, Macao, Malta, Mauritius, Panama, and Qatar were also fingered.
Over the 2014– 2020 period the report said the banks surveyed had booked €20bn (or 14%) of their total profits in tax havens each year. They added that this percentage has been stable since 2014 despite the introduction of mandatory information disclosure. “Bank profitability in tax havens is abnormally high: €238,000 per employee, as opposed to around €65,000 in non-haven countries,” said the report.
Tax deficit calculated
They then sought to calculate how much revenue European state treasuries are losing as a result of this hypothesised tax dodging. By comparing the effective tax rates paid by banks with mooted global minimum tax rates they arrived at figures for tax deficits. They considered three minimums: 15%, 21%, and 25%, the central figure of which is currently being advanced by the OECD as a potential future minimum global corporate tax rate. On this basis the researchers estimated the tax deficit would range from €10-13bn per year with a 25% rate, €6-9bn for the 21%and €3-5bn for 15%.
“Our findings signify the importance of implementing additional measures that complement the public disclosure requirement, to address the profit shifting and tax planning behaviour of multinational enterprises,” concluded the authors. However, what is the validity of this assertion? Helpfully the report includes detailed information broken down by country to highlight the extent of the potential losses.
Is €20bn a large number?
Taking the example of Germany, the study calculates that the “tax deficit” for the German state due to profits being booked in tax havens was €24.8m in 2019. This compares to total tax revenue in Germany in that year of €1.3trn, with tax on company profits at €69.4bn, according to the OECD. Thus the tax deficit equated to 0.04% of all German corporate tax and 0.002% of the entire tax take. Even if the highest annual tax deficit in this study was taken (€149m in 2016) this equates to 0.25% of corporate tax and 0.01% of all tax levied in Germany.
Moreover, the Germany state was deemed to have “lost” three times more tax revenue to countries judged by the authors not to be tax havens, than was the case for the 17 jurisdictions labelled as tax paradises. In fact, the country most affected by the tax deficit, according to the report, was the UK. Eleven European countries were studied. Throughout the period of the study the UK accounted for 70-90% of the total tax that the EU Tax Observatory claim was lost via tax avoidance using havens. That the UK is a global financial service hub may have had something to do with this.
How relevant?
“Comparing the profitability of certain banks in Luxembourg to those in countries which have large retail networks is not relevant,” said Nicolas Mackel CEO of the trade promotion body Luxembourg For Finance. Indeed, the report highlighted banks present in Luxembourg which have cross border wealth management and fund servicing activities: profitable, scalable business lines that don’t need large workforces.
Also, the choice of 15% as the benchmark for being a tax haven is not explained in the report. That this is the rate apparently charged in Luxembourg, which “everyone knows” is a tax haven might have influenced this decision. The report also notes that the average EU effective tax rate was 20%, thus not substantially higher than in the Grand Duchy.
It is probable that profit shifting within banking groups occurs, just as it does in other multinational companies. Yet whether this is such a significant problem as is generally assumed might need to be proven.