There is no evidence that banks are shifting profits to Luxembourg to dodge tax, one of the authors of a recent controversial report by the EU Tax Observatory has said. Yet if this is so, why does the think-tank label Luxembourg a “tax haven” for banks? We asked one of the report authors to explain.
In the EU Tax Observatory report published last week (which Investment Officer Luxembourg analysed), Luxembourg was called a banking sector tax haven and was ranked alongside 16 other financial sector jurisdictions as such, including the Bahamas, Ireland, Mauritius and Hong Kong. This claim received considerable press coverage that was largely negative in tone, both nationally and internationally.
Yet Luxembourg industry representatives and politicians complained that the report failed to account for the unique nature of the Grand Duchy’s banking sector. We put these and other questions to Mona Baraké, one of the report’s authors. She is a post-doctoral scholar at the EU Tax Observatory.
Investment Officer: The report has been criticised for comparing financial sectors like Luxembourg’s –which serves international clients – with those that principally serve domestic retail clients. These are fundamentally different business models. How do you respond to that criticism?
Mona Baraké: In previous studies we have compiled lists of tax havens using other methodology. In this project we found that Luxembourg banks have a very high ratio comparing profit with the number of employees, and this was one of the two benchmarks we used in this study when compiling the list of tax havens.
Investment Officer: Yet is it not the case that Luxembourg’s banking model if very different from most others, and this makes it difficult to compare?
Mona Baraké: Of course, it is not easy. The data that we have are not very detailed, so we cannot really see other variables that would be more striking evidence. We are only able to calculate a few ratios from the available country-by-country data. But from a macro level banking activity in Luxembourg is not symmetrical to real economic activity in the country.
Investment Officer: Yes, because it only serves a small domestic market but mainly serves a European, and sometimes global market.
Mona Baraké: We didn’t say in the report that there was tax evasion. We are just saying that the activity was disproportionate.
Investment Officer: OK but wasn’t the implication of the report that this was due to profits being shifted to Luxembourg from other countries for tax reasons.
Mona Baraké: But we didn’t say this in the report. We said that this might reflect the reality. We cannot prove it with the data that we have. We advocate having more transparency and having extra data to be able to prove that. The country-by-country reporting data has nothing on bank deposits and assets, this is why it’s not possible to say if there is profit shifting or not.
Investment Officer: The report stated that Luxembourg banks have an effective tax rate of 15%, which is not far from the EU average that you calculated of 20%.
Mona Baraké: In fact, we found that, depending on the year [2014 and 2020 were studied in the report], Luxembourg’s effective tax rate varied between 11.9% and 17.8%. We expected it to be lower, and it is one of the higher rates compared to the other tax havens. So it is just the profitability-to-employment ratio that made us put in on the list, not necessarily the tax rate.
Investment Officer: But “tax haven” is quite an emotive, non-neutral term that attracts attention, and the Luxembourg banking industry doesn’t like this categorisation So, given that the effective tax rate is close to the EU average, how to justify using the term “tax haven”.
Mona Baraké: I guess to be a tax haven is not necessarily about being a low tax country, but maybe characterised by good governance, opacity, preferential treatment and so on.
Investment Officer: Let us turn to the calculations in the report for the potential “tax deficit” for the tax administrations of the 11 countries in which the banks in the study are headquartered. This is put at between €3bn and €13bn in the EU and the UK. The total tax take in the EU27 last year was around €5.3trn, hence even the upper figure in the report represents about one quarter of one percent of the total. Is this really a big problem?
Mona Baraké: Yes, it is true that revenue when compared to GDP is very small. Yet it constitutes 18% extra taxes with respect to what the banks are currently paying. So, it is not a lot but that is still a significant sum for the banks concerned. Moreover, this figure only relates to the 36 banks analysed in this report, which were the banks judged to be systemically important in the EU and the UK.
Investment Officer: The presence of the UK in the calculations is significant given the size of its financial sector. So the overall figure for the EU is less than the headline figures?
Mona Baraké: Yes, and if one takes the minimum tax deficit estimate of between €3bn to €5bn the UK alone would account for about €1bn. We published this data because it was collected for the UK.
Investment Officer: What is the role of the EU Tax Observatory?
Mona Baraké: Our key missions are to conduct research on taxation, with a focus on tax evasion and fraud, and offer potential solutions to these problems. We also work to promote debate on the future of taxation, and provide access to knowledge on taxation
Investment Officer: From where does it receive funding and what is the total budget?
Mona Baraké: The budget is around €1m, with 80-90% of this coming from the EU. We are hosted by the Paris School of Economics which provides the remaining funding. This EU funding was as a result of us winning a call for tender.