Luxembourg is one of six countries that are most competitive in terms of taxes among the world’s 38 most developed economies, according to the latest International Tax Competitiveness Index.
While this might seem to lend ammunition to those who criticise Luxembourg as a tax haven, the picture painted in the report is somewhat nuanced. For example, it also ranks fellow cross-border business hub Ireland as 35th out of the 38 OECD member states.
This index, calculated by the Tax Foundation, a US-based think tank, uses five broad metrics to assess tax competitiveness. Two of these are directly relevant to discussions about tax competition used to attract inward investment: the corporate tax ranking and the cross-border tax rules ranking.
Luxembourg however ranks a relatively low 26th in the former but fifth in the latter. It is worth noting that Ireland’s scores were almost opposite: ranked high for the tax rate but near the bottom for cross-border tax rules.
Corporate tax examined
The index breaks the corporate income tax measure into three subcategories. A “corporate rate” subcategory is based on the top marginal corporate income tax rate. It appears that the study uses the headline rate for corporate tax, without adjustment for the kind of tax planning rulings that international companies can agree with the authorities.
When it comes to tax rulings, Luxembourg is placed 20th on this measure as the 24.9 per cent the report quotes for the corporate tax rate is in the middle of the pack. The three Baltic states are highest placed, followed by Ireland.
The other subcategories are “cost recovery” (the extent to which costs can be written off against tax) and “incentives/complexity” (how much the tax code seeks to encourage or discourage certain activity). Luxembourg is placed 14th and 29th respectively.
The authors of the survey (which come from an economically liberal standpoint) dislike incentives due to their propensity to “distort economic decisions.” For example, the authors disapprove of so-called “patent boxes” which give favourable tax treatment for income derived from intellectual property. The grand duchy is one of 16 OECD countries, including France and Belgium, with a patent box regime.
Sharpe of cross-border tax
Cross-border tax rules, on the other hand, are broken down four ways. The grand duchy is ranked joint-first, along with 13 other OECD countries, for the extent to which dividends and capital gains can be exempt. All these states received 100 out of 100 on this measure, which is about the ability of a subsidiary to either reinvest its profits into ongoing activities or distribute its profits back to the parent company in the form of dividends. Ireland is ranked second from bottom on this.
In the withholding taxes subcategory, Luxembourg ranks fourth, as these taxes are relatively low in this country, and regarding the number of tax treaties, it is 17th. The fourth subcategory is “anti-tax avoidance” for which Luxembourg is placed eighth. The report gives a higher ranking to the countries that impose the fewest rules related to corporate tax planning.
Costa Rica, Switzerland and Israel are in the top three in this latter category with scores in excess of 80 out of 100. Joint fourth with 65/100 come Australia, Canada, New Zealand and Slovenia. Luxembourg then follows in a peloton of 14 countries ranked eighth with 47/100. Ireland, The Netherlands, Germany and Belgium are also in this group.
Hence the impression given is that Luxembourg is never out ahead on its own in any one measure. Yet it manages to be not far behind the leaders in most categories.
Pros and cons of Luxembourg
The survey addresses the wider question of tax, not just related to cross border investment and trade. One of its three bulletpoints for what it perceives as the strong points of Luxembourg’s tax system is that it “applies its relatively low VAT rate of 17 per cent to nearly 80 per cent of final consumption.” Only New Zealand imposes consumption tax to more of the taxable base.
Other leading advantages in Luxembourg are said to be: “business investments in machinery and intangibles receive better-than-average tax treatment” and “capital gains are tax-exempt if a movable asset such as shares is held for at least six months.”
As for weaknesses, the report cites: “companies are limited in the time period in which they can use net operating losses to offset future profits and are unable to use losses to offset past taxable income,” “several distortionary property taxes” and “a solidarity tax which acts as a 7 per cent surtax on personal income.”
As can probably be deduced from this analysis, the Tax Foundation is right of centre on economics and pro-business as a think-tank. Its board includes representatives of the likes of PwC, Microsoft and PepsiCo.
