Can Juncker survive 'Lux Leaks'?

Once upon a time, newly elected officeholders enjoyed a 100-day grace period to allow them to get their feet under their desks and become acquainted with their new jobs. Not so Jean-Claude Juncker. The new president of the European Commission, in office since  November 1, already has to fight for his political survival over a corporate tax scandal.

Last week's release of thousands of leaked documents shows how the Luxembourg government was complicit in arranging a giant, (potentially) technically legal tax avoidance scheme for large companies. It makes a mockery of Jean-Claude Juncker's claims to be a political leader concerned with pan-European solidarity.

Luxembourg, a founding member of the European Union, became rich through its finance sector. For many decades, it was a prime destination for grey money. To save tax on interest income, vast amounts were transferred to the small Grand Duchy where discreet banks prevented them from being taxed.

Under pressure from its European neighbours, Luxembourg had to curtail such practices so that from 2015, foreign-held accounts will be reported to the tax authorities in the accountholder's home country. Earlier this year, experts estimated that around €50 billion of grey money was still deposited in Luxembourg -- money that quickly needs to be smuggled across the border in order to avoid future tax troubles for its owners.

For Luxembourg, however, the end of its tax avoidance model for individuals seems to have made it more creative in tapping other sources of revenue. According to the leaked documents, the government has devised ingenious ways of corporate tax avoidance. Jean-Claude Juncker, who was Luxembourg's prime minister from 1995 to 2013 and finance minister from 1989 to 2009, will find it hard to convince the European public that he of all people was unaware of what was going on within Luxembourg's tax system.

The way the Luxembourg tax evasion model works is complicated on the one hand and incredibly simple on the other. The complicated bit is the cascades of companies set up in order to channel profits from other European countries to Luxembourg. The simple bit is that once profits become taxable in Luxembourg, hardly any taxes need to be paid.

Luxembourg's officials would deny the country is a tax haven at all. They would point out that there are perfectly normal tax rates in place in their small country so that corporate profits would be subjected to about 29 per cent in tax. That is about the same as in Germany and somewhat less than in France, but it is certainly not a ‘classic' tax haven such as the Cayman Islands.

However, as the so-called ‘Lux Leaks' documents reveal, the Luxembourg authorities were extremely cooperative in granting favourable conditions for international companies setting up shop in their country.

The practice has been known for many years, and anyone who has ever ordered books from one of Amazon's European subsidiaries would be familiar with it. Whenever you order from amazon.co.uk or amazon.de, sales are not made through the British or German subsidiaries of the US retail giant; they are always sold through Amazon EU S.a.r.L., its Luxembourg-based subsidiary.

This has enormous tax implications, not least because Luxembourg allowed the company to offset almost its entire revenue against charges from other companies. It also grants generous discounts on income resulting from intellectual property and exempts interest income from taxation altogether. For lawyers and tax advisors, this opens ample opportunities to design tax avoidance schemes -- and get them pre-approved by the Luxembourg tax authorities.

Such constructions are entirely absurd. Amazon's books, for example, may be ordered by British customers, packaged in UK depots, and the invoices printed in Britain – and yet, without any direct involvement in any of these transactions, the payments will flow through Amazon's Luxembourg subsidiary. British newspaper The Guardian already reported in 2012 that this arrangement meant Amazon EU S.a.r.L. only reported profits of €55 million from sales of €23 billion. Taxes on this came to just over €15 million -- all of it paid to Luxembourg.

Amazon was not the only company using Luxembourg's wide-open loopholes in order to minimise its tax liabilities. The list of tax avoiders reads like a ‘Who's Who' of multinational businesses: Swedish furniture giant IKEA, German utility E.ON and US logistics company FedEx were among the corporates benefitting from the arrangements.

The allegations against Luxembourg are certainly not new. What is new, however, is that there is now conclusive proof how complicit its government was in allowing these companies to avoid taxes -- taxes they would otherwise have had to pay in other European countries in which they operated.

It is impossible to imagine how any senior government official, least of all the prime minister or the minister of finance, would not have known about Luxembourg's tax avoidance deals. Luxembourg is not a vast country, after all. So for Jean-Claude Juncker to now pretend that he was somehow unaware of how his tiny country managed to attract multinationals to set up shop is simply ludicrous.

As President of the European Commission, Jean-Claude Juncker now has to investigate his own country (and probably the actions of the government he once led) and see whether they comply with EU law. Even if they did, there is a difference between complying with the letter of the law and its spirit. Luxembourg's model of generating tax revenue depends on harming its European neighbours. This was not ordinary and justifiable tax competition; this was higher tax alchemy with no other purpose than to generate some extra income for a small country based purely on legal fictions.

Jean-Claude Juncker should have a hard time explaining his involvement in this scandal. But then again, he is Europe's most experienced expert in selling such contradictions. One might even say that he made a political career out of them (The phantom giant of Luxembourg, June 30 2011).

Whether Juncker's political career will come to an abrupt end now depends entirely on whether he can sufficiently distance himself from the Lux Leaks revelations. Or indeed, whether those who elected him to his new office will award him a grace period regardless.

Dr Oliver Marc Hartwich is the executive director of The New Zealand Initiative.