By Matthew Karnitschnig and Robin van Daalen
LUXEMBOURG--On the first floor of a rust-colored building near
the main railway station, Marius Kohl spent years engineering this
country's most valuable export: tax relief.
As head of a federal agency called Sociétés 6, Mr. Kohl approved
thousands of tax arrangements for multinational corporations,
sometimes helping them save billions.
Sociétés 6's official function is to determine how much tax is
owed each year by roughly 50,000 Luxembourg-registered holding
companies, most of which have foreign parents. International
regulators say the authority has acted more as a facilitator,
endorsing confidential tax arrangements that bring business to
Luxembourg while allowing global companies to avoid paying what
regulators consider the companies' fair share of taxes
elsewhere.
Known in financial circles as "Monsieur Ruling," Mr. Kohl, who
retired last year, had sole authority at Sociétés 6 to approve or
reject the tax deals. Foreign companies flocked to the tiny country
during his tenure because of the speed and ease of the approval
process, local tax advisers say.
"I could say 'yes' or 'no,' " Mr. Kohl, a bearded 61-year-old
with a ponytail, said in a recent interview, which he described as
his first. "Sometimes it's easier if you only have to ask one
person."
The European Union's executive arm said this month it is
investigating whether Luxembourg's tax deal with Amazon.com Inc.
violated rules against state subsidies to an individual company. It
is looking into similar arrangements with Fiat Chrysler Automobiles
NV and has hinted that more probes will follow. Luxembourg and both
companies say they have adhered to international tax rules and have
done nothing wrong.
In Luxembourg, foreign companies have access to deductions and
holding structures that can slash their tax bills from the 29%
headline corporate rate to close to zero. Often, they pay little or
no tax on income from royalties, dividends, interest, proceeds from
liquidations or capital gains.
Even as Europe has standardized rules on everything from light
bulbs to bolts, tax policy remains the province of national
governments. But with many countries struggling to reduce debt,
there is pressure on the EU to take a tougher line with tax-outlier
governments.
Much attention has focused on Ireland and its role in helping
companies slash taxes. Dublin this month moved to scale back its
breaks. EU authorities have also zeroed in on the Netherlands,
where Starbucks Corp.'s European roasting operation is under
scrutiny. Starbucks has said it complies with all relevant tax
rules.
Regulators say no European country has been as aggressive as
Luxembourg over the years in using tax breaks and confidentiality
to lure international businesses.
A review of its tax system last year by other countries under
the auspices of the Organization for Economic Cooperation and
Development concluded that Luxembourg didn't comply with
international standards of transparency and exchange of
information.
"Luxembourg's wealth comes from helping companies not pay taxes
in the countries where the value was created," says Pascal
Saint-Amans, a senior official at the OECD who is spearheading an
international effort to overhaul corporate-tax rules. "Instead of
creating value, they create tax advice."
Luxembourg's finance minister, Pierre Gramegna, says his country
fully complies with global standards and isn't a tax haven.
"We always go by international rules," says Mr. Gramegna, who
until last year led the country's chamber of commerce. He said
legislation to address the OECD concerns would be implemented this
year.
The OECD last month presented proposals to standardize rules for
taxing international companies, which would force more transparency
and make it harder for companies to shift profits to low-tax
places. Before the proposals can take effect, countries must turn
them into national law. And a key issue remains unresolved: how
much operational heft a company must have in a country to declare
that country its tax home.
U.S. companies operating abroad generate about 9% of their
foreign profits from Luxembourg-based subsidiaries, on the whole,
while employing only 0.1% of their foreign workforces in the
country, figures from the Commerce Department's Bureau of Economic
Analysis show.
For Luxembourg-based units of U.S. companies, the effective
income-tax rate has been as low as 0.4% in recent years, according
to an analysis by Kimberly A. Clausing, an economics professor at
Oregon's Reed College. Much of the foreign profit of American
companies never returns home to face the U.S.'s 35% corporate tax
rate.
Forcing Luxembourg to dismantle its system would be difficult.
The country's financial-services sector, which accounts for 36% of
its economy, depends on a permissive tax environment and
discretion.
That business has made Luxembourg, population 550,000, the
world's richest country on a per capita basis, according to the
International Monetary Fund. The wealth is rooted in thousands of
jobs for bankers, lawyers and auditors. There are 149 banks
registered here. The mutual-fund sector ranks second in size after
the U.S.'s, with $3.3 trillion in assets under management.
The country is a hub for cash flows. Using complex structures
and the favorable tax regime, companies move hundreds of billions
of dollars a year in and out. Over a decade, investments held by
foreign businesses in Luxembourg quadrupled to $3.2 trillion, more
per capita than in any other country, according to OECD data.
It is also Europe's center for e-commerce. EU rules allow online
retailers based in Luxembourg to levy its sales tax--lower than
other countries'--for digital purchases around the Continent. The
EU recently changed that rule, a move the government expects to
cost it about EUR700 million ($894 million) in annual tax
revenue.
Business is robust despite such headwinds. Luxembourg has
adopted some of the changes demanded of it, most recently by
agreeing to scrap its banking-secrecy laws, only to carve out new
tax-friendly niches such as tax-exempt holding structures for
wealthy foreigners, local tax advisers say. Ernst & Young LLP,
KPMG LLP and PricewaterhouseCoopers LLP have invested in new office
complexes, and several Chinese banks have recently made Luxembourg
their European base.
Luxembourg's success in preserving its allure as a tax home in
the face of international pressure is a testament to its sway in
Europe.
As a founding member of the EU, Luxembourg has long acted as an
arbiter between the Continent's two heavyweights, France and
Germany. Its leaders played a central role in ushering in the euro.
It is home to institutions such as the European Court of Justice.
Its longtime premier, Jean-Claude Juncker, was recently elected to
the presidency of the European Commission.
As prime minister from 1995 through last year, Mr. Juncker was a
staunch defender of Luxembourg's tax system and the principle of
tax competition within the EU. "No one has ever been able to make a
convincing and thorough case to me that Luxembourg is a tax haven,"
he recently said on German television. "Luxembourg employs tax
rules that are in full accordance with European law."
Nestled in the hill country between Belgium, France and Germany,
Luxembourg, the world's last grand duchy, is smaller than Rhode
Island, with about half the population. Its economy long relied on
steelmaking, but with a decline of that industry in the 1970s,
Luxembourg focused on expanding its financial sector by offering
tax breaks for foreign capital. Its bank-secrecy laws attracted
billions in deposits.
Though the roots of its tax regime reach back 85 years, foreign
corporations started coming in large numbers in the early 1990s. A
reason was that Luxembourg was quick to adopt an EU directive
allowing companies to pay taxes in a European headquarters country
rather than where their other subsidiaries operated.
Luxembourg also expanded a web of tax treaties: bilateral
agreements to prevent corporate income from being taxed twice.
Luxembourg has 73 of these and 19 more pending.
While a number of other countries also offer attractive tax
setups, a quality that makes Luxembourg a pillar of corporate tax
strategies is trust, tax advisers say.
"There's real stability," says Phillipe Neefs, a senior partner
at KPMG in Luxembourg. "The law is very clear. And if it's not
clear, there's an open line with the ministries."
Financial authorities' close relationship with business has
raised eyebrows in neighboring countries. A particular annoyance is
Luxembourg's tax-ruling system. A company presents a holding
structure to the tax authority before putting it into place, to
find out how its tax bill would be calculated. The advantage for
companies is threefold: They can make adjustments if the tax office
has a problem with the structure; once approved, a structure is
binding for five years; and it is all confidential.
"Tax rulings are only there to provide certainty, which is a key
point for companies," says Alain Steichen, a tax attorney who also
advises the government.
During Mr. Kohl's 22-year tenure, an additional advantage was
that in many cases, companies could get an informal nod from him
before their application went under review. In most European
countries, getting a tax ruling is a lengthy process. In
Luxembourg, it often took one meeting.
Mr. Kohl usually hosted company representatives and their tax
advisers in his large corner office at Sociétés 6. Decor was modest
except for a Pirelli calendar--a gesture of gratitude, he says,
from the tire company for his help in navigating the tax system.
The limited-edition calendars, featuring suggestive pictures of
famous models by star photographers, are a status symbol, sent to a
select group including celebrities and corporate leaders.
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Seated at the center of a conference table, Mr. Kohl would often
go over several company dossiers with tax advisers in one
sitting.
"We would meet him once a month, and if [a tax structure] was
OK, you could basically do the deal right away," says Marc Schmitz,
head of taxation at the Luxembourg branch of Ernst & Young.
Mr. Kohl earned a reputation for always honoring his preliminary
rulings. "He never changed his mind," Mr. Steichen says.
With thousands of case files and a staff of 50, Mr. Kohl
regularly worked from early morning until 9 p.m. "I wanted to make
sure everyone was served," he says, sitting at his kitchen table in
Esch-sur-Alzette, a steelmaking town where he was born.
Mr. Kohl says none of his superiors in the finance ministry,
including Mr. Juncker, who served as finance minister for two
decades, questioned or criticized his approach at Sociétés 6.
"I didn't get any pressure from above," he said. "I never had
any problems with Juncker."
Within Luxembourg's close-knit tax advisory community, Mr. Kohl
is regarded as an unsung national hero.
"He deserves a medal," says Mr. Steichen. The corporate
structures Mr. Kohl approved account for up to 80% of Luxembourg's
EUR1.5 billion in annual corporate tax revenue, Mr. Steichen says.
"He worked his socks off."
Mr. Steichen, who has known Mr. Kohl for decades, says the tax
inspector was always careful to follow the law, "but if he could
take the business-friendly reading, he would."
European Commission investigators suspect some of the
arrangements violated rules prohibiting state aid to companies. The
commission's probes of the Fiat and Amazon tax rulings concern
whether prices the companies' Luxembourg affiliates charge other
company subsidiaries elsewhere for services and the use of
intellectual property were set at "arm's length" or were designed
to reduce the tax hit.
During Mr. Kohl's time as chief of Sociétés 6, the arm's-length
test--an OECD rule--wasn't anchored in Luxembourg's tax law. Nor
were companies required to provide detailed documentation to
support their calculations.
Asked how he determined whether a company's pricing information
was accurate, Mr. Kohl licked his thumb and held it up in the
air.
"There was no way to verify it," he said.
Luxembourg has been reluctant to share its corporate tax
rulings. It initially rejected the European Commission's request
for information on its tax rulings. After the EU threatened to take
it to court it provided details on the Fiat and Amazon rulings, but
it still refuses to provide a broader set of information requested
by the EU.
"Every country has its laws, its traditions," says Mr. Gramegna,
the finance minister. "If some countries think that confidentiality
is not an issue in terms of taxation, that everything should be on
the Internet on everybody, that's a choice. It's not ours."
In 2012, several of Sociétés 6's rulings ended up in the hands
of a French journalist who disclosed details in a documentary on
French TV, revealing that a number of large companies had avoided
paying taxes in their home countries by channeling profits to
Luxembourg.
In 2013, Mr. Kohl took early retirement, after 37 years at the
tax office. A team of six replaced him. Oral rulings are no longer
permitted, and the waiting time can now be as long as six months,
tax advisers say.
Reflecting on his time at Sociétés 6, Mr. Kohl says he had no
regrets.
"The work I did definitely benefited the country, though maybe
not in terms of reputation," he says.
Write to Matthew Karnitschnig at matthew.karnitschnig@wsj.com
and Robin van Daalen at Robin.VanDaalen@wsj.com
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