Grand Duchy battles on in defence of foundations underpinning its prosperity

Date: 03/06/1999

By Tim Jones

LUXEMBOURG began life in the tenth century as the most heavily defended citadel in northern Europe.

Ask a taxman in Germany or Belgium and he will tell you that, nine centuries on, little has changed.

Seventy-year-old fiscal legislation has made Luxembourg a magnet for foreign banks, investment funds and holding companies keen to establish their European headquarters in a tax-friendly environment.

Today, for all their new-fangled tax breaks, the Irish and the Danes cannot come close to the concentration of 1,300 investment funds and 220 banks (one per 1,800 people) which can be found in the Grand Duchy.

They also cannot come close to the amount of footloose German and Belgian cash which is salted away in these banks' vaults.

The combination of guaranteed bank secrecy and no tax withheld on interest at source by the local authorities make the trip to Luxembourg well worth it.

It has turned into big business involving all the continent's biggest banks. There was embarrassment all round when two German bank executives were jailed for talking a Koblenz businessman into reducing his tax liability by shifting €3 million into their Luxembourg branch.

Revelations by a disgruntled Kredietbank-Lux employee about 40,000 Belgian accounts stunned the Brussels authorities. Experts in Germany estimate that as much as €150 billion in potential public revenue has been salted away in Europe's tax havens, with most in Luxembourg.

It may be hard to justify but, along with the Acieries Réunies de Burbach-Eich-Dudelange (ARBED) steel group, this system has made Luxembourg rich. The prime ministers who have been faced with European Commission attempts to impose common withholding taxes - first Jacques Santer and now Jean-Claude Juncker - were never going to give up their privileged position without a thoroughly communautaire bare-knuckle fight.

During Santer's premiership it was pretty easy, since the first proposal for a savings tax in 1989 was fatally flawed. A 15% rate was to be imposed across the board and threatened to drive banks out of the City of London. The British killed the proposal for him.

When he took over as president of the Commission, he knew better. The plan devised by Internal Market Commissioner Mario Monti allowed member states to choose between a 20% rate or an exchange of information: essentially forcing paying agents (banks which specialise in paying interest to investors) to give details of interest paid to an individual's tax authority. He also confined the terms of the withholding tax to EU-resident individuals collecting their interest in another country.

But Juncker still tried to hold out. "Luxembourg is not a tax paradise but the European Union, in fact, is an area of 15 tax paradises," he said. "We need to take a broader approach to tax harmonisation in Europe - mainly as far as corporate taxes are concerned - not only the level of nominal rates but also the basis on which these nominal rates have to be applied."

Knowing this would never happen, he could still play the EU statesman. Unfortunately, Monti countered by devising a 'code of conduct' to outlaw what he termed "unfair and harmful tax competition" between member states in the field of corporate tax.

Juncker des-patched his Budget Minister and Christian Democrat lieutenant Luc Frieden to argue for the code to go further, by calling on the Commission to draft a directive on corporate tax poaching.

Nobody listened to him or took him seriously, but he was saved by the re-emergence of British opposition to the new proposal, based on its cost to London-based paying agents and a perceived threat to the market for tradable foreign-currency debt ('eurobonds').

For the past year, Juncker and Frieden have been able to keep their heads down and hope the British would sink the directive - at least until next week's election is out of the way.

When UK Finance Minister Gordon Brown started talking in terms of a compromise, panic spread through Luxembourg city. Juncker now knows that, once the election is over, he will probably have to choose between cultivating his image as an integrationist European statesman in the Helmut Kohl mould, or exercising his veto and looking British.