Occupying a damp 1,000 square miles where the French, German and Belgian borders meet, the Grand Duchy of Luxembourg is a far cry from the palm-fringed tropical island tax haven of popular imagination.
In fact the country owes its status as the world’s premier corporate tax haven to its position at the heart of Europe. A founding member of the European Economic Community in 1957, Luxembourg enjoys all the freedoms governing investment in what is now the European Union. These and a network of taxation agreements with all the world’s leading economies ensure the Grand Duchy is accepted in a club of leading nations that share basic principles on how to tax corporations operating across national borders.
Such a privilege would never be afforded to island-in-the-sun tax havens. Large economies, such as the US and UK, typically block multinationals from shifting profits to low-tax territories by imposing ‘withholding taxes’ on payments leaving their borders. Luxembourg, by contrast, is a respected member of the international economic club, and assumed therefore to tax its companies fully; it even has a corporate income tax system with a 29% rate that is now relatively high by international standards. So money flows into the country tax-free.
Secretly, however, Luxembourg is a tax haven, offering a range of ways in which payments that reduce a multinational’s taxable profits in a country such as the UK or US can escape tax when received in the Grand Duchy. These include: exempting income diverted to foreign branches of Luxembourg companies in places like Switzerland and Ireland, tax relief for paper investment losses, and the approval of complex ‘hybrid’ financial instruments and corporate structures within its borders. Top FTSE 100 firms like Vodafone and GlaxoSmithKline are known to have exploited these opportunities to channel billions through Luxembourg companies.