Incentives Deal of the Month
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by ADAM BRUNS, Site Selection Managing Editor
According to the recently released 2006 Index of Economic Freedom, Luxembourg ranks fourth among 157 countries in its openness and freedom, just behind Ireland, Singapore and top-ranked Hong Kong.
Whether the country will remain free to pursue its own economic policies is a hazier proposition.
In early February, the European Commission said it will be looking anew at the Luxembourg laws that exempt more than 12,000 holding companies from corporate taxation, because such laws may favor companies based there over other EU locations, thereby violating economic development principles the EU is trying to promulgate in order to tread the thin line between freedom and fairness. The OECD has also been looking hard at the fairness and flexibility issues of tax competition.
The topic reverberates particularly well in the U.S. right now, as the U.S. Supreme Court on Wednesday, March 1, heard arguments in the appeal of the Cuno v. DaimlerChrysler federal appeals court decision, which basically asserted that tax-break provisions inherent in state incentives programs violated the Commerce Clause of the U.S. Constitution.
The Luxembourg scrutiny also echoes another recent occasion when the EU brought down the hammer, in this case with the No. 3 country in the economic freedom rankings, Ireland. In early 2005, Ireland's legendary accommodations for business raised the ire of EU regulators, who blocked the application of the country's US$320-million grant for Intel's proposed $1.8 billion worth of fab expansions in Leixlip. According to published reports, a separate, $94-million grant was still passing muster with the EU, but company officials indicated initially that all projects were under review in light of the bigger grant's coerced withdrawal.
Transparency vs. CompetitionFor its part, the Grand Duchy's government has already moved on the issue, having removed the tax exemption for new companies and grandfathered the old ones only through 2010. The major tax reform was implemented in January 2002, and emphasized the duchy's growing financial services momentum, as opposed to being a haven. While old-style holding companies still exist, the new mechanism is something called a "societe de participation financiere" or SOPARFI, which "provides for a participation exemption for qualifying investments held directly or indirectly by resident taxable companies and qualifying branches of non-resident companies," says a KPMG Tax Advisors guide to the country. The income tax exemption extends to dividends, capital gains and liquidation proceeds.
Meanwhile, the country of 450,000 tries to play on its central geography and its industrial heritage in order to get multinationals as interested in moneyed structures as they are in structured money.
The original laws opening the way for holding companies were enacted the same year as the Luxembourg Stock Exchange opened, in the infamous financial disaster year of 1929. But the real momentum in holding company location did not begin until the mid-1960s with the creation of the Eurobond market, and was exacerbated in the 1970s by monetary policy moves in neighboring countries:
"In the early 1970s, requirements were adopted for monetary policy reasons to set aside monetary reserves or to make deposits with the central banks in West Germany and Switzerland in particular, which gave fresh impetus to the international development of the Luxembourg financial center," explains the Luxembourg government's carefully worded history. "The measures taken by West Germany and Switzerland to discourage deposits by non-residents in their currencies led to the relocation of international banking business to another off-shore center. This relocation was highly beneficial to the market in Luxembourg on account of both its geographical and linguistic proximity to the countries in question and on account of the advantages of its legislation.
"However, the real boom in Luxembourg's Undertakings for Collective Investment occurred in 1983 with the implementation of the first law formally organizing these undertakings by creating open-ended investment companies (SICAV)," the site continues. "The net assets of the Undertakings for Collective Investment rose from 29 billion francs in 1967 to nearly 10000 billion francs in 1994." A 2003 KPMG guide notes that 1,900 investment funds were registered in Luxembourg, valued at 854 billion euros, or nearly US$890 billion at 2003 exchange rates.
Certainly the conditions for holding company establishment are still ripe. Reviews by the EU, OECD or any other entities aren't stopping anyone from exploiting the status quo on the ground. As recently as late January, one of the reasons Amazon gave for placing its European headquarters in Luxembourg was "interesting fiscal opportunities," according to the country's board of economic development. Sales and service functions will relocate to the Grand Duchy, also driven by the region's multilingual capabilities and political stability.
But the Luxembourg legacy is steel, as even today its largest employer, at 6,700 employees, is Luxembourg-based Arcelor Group, the latest takeover target of Mittal Steelz which has itself just purchased a 38-percent stake in China's Laiwu Steel Corp. One of the three companies that formed Arcelor in 2002 was Arbed, founded in Luxembourg in 1911 after its predecessor company had established initial operations there in 1886.
Arcelor in September 2005 opened a new 200-worker rolling mill in Esch-Belval, an investment of more than $201 million. Roland Junck, senior executive vice president Arcelor Long Carbon Steel, said it was part of the "Lux 2006" plan aimed at "revitalizing Arcelor's steel plants and wire-drawing facilities in Luxembourg," according to a company news release, in order to reduce vulnerability to "competition from emerging countries."
In early November 2005, Italian plastics maker Tontarelli pledged to invest in a new 73,000-sq.-ft. (6,782-sq.-m.) injection molding plant. That adds to the company's plants in Italy, Great Britain, France, the Czech Republic and Germany, as well as two distribution centers in Spain and Germany. The new plant in Bascharage's Bommelscheuer Industrial Park will receive an investment of $10 million and employ around 40. The company joins a plastics contingent in Luxembourg that includes major operations from Husky and Rubbermaid.
Other large employers, in order, include Goodyear in Colbar-Berg, glass producer Guardian Group (European HQ and other operations in three cities) and DuPont de Nemours Group in Contern, where 1,260 employees make such recognizable brands as Tyvek and Mylar.
Guardian was involved in a U.S. federal claims court lawsuit decided in its favor in early 2005. At issue was whether it was entitled to a $2.7-million tax refund from the IRS based on its entitlement to a foreign tax credit. Overall, the company has invested some $200 million in the Grand Duchy, and employs 1,200 people.
Chief to the country's hub strategy, however, is its automotive sector, which employs nearly 8,000 people on 30 sites. In addition to Goodyear, their number includes Fanuc, Faurecia and Delphi. According to the Board of Economic Development, "These companies deliver their products to over 20 car manufacturing plants within a range of 300 km. [187 miles] and to over 50 plants within a range of 600 km. [373 miles]."
Population figures lend substance to counter the perception of a shadow economy. Since 1981, the duchy's population has grown by 23 percent, with the "alien" population growing to 170,000 from a mere 96,000. According to European Commission statistical resource Statec, that alien population is led by Portugal as country of origin, accounting for more than 61 percent of the alien population. In order, the next most visible expats are the French (21 percent), Italians, Belgians and Germans, with "other" (including the U.S.) accounting for nearly 25 percent.
More than One Reason
That development comes at the same time as a new law has come into effect, notes Roger Molitor of KPMG Tax Advisors in Luxembourg, who co-authored, with Sandrine Degreve, a January 2006 commentary in "Tax Notes.": "Luxembourg has reduced its municipal business tax rate for Luxembourg City, effective January 1, 2006, thereby reducing its statutory corporate tax rate from 30.38 percent [the duchy's rate] to 29.63 percent for companies established in Luxembourg City."
But even though that corporate tax rate is high in comparison to some of its EU brethren, Luxembourg compensates with value-adds like the lowest value-added tax rate on e-commerce of any EU country. In fact, its effective corporate tax rate is second lowest in the EU, while its labor productivity is among the highest in the world.
Among the authors' other observations was that while tax revenue on corporate income represents only 8.6 percent of total taxation within the European Union, "that average covers a broad bandwidth, for example, Germany at 3.5 percent and Luxembourg at 19.1 percent in 2003." Competitive tax policy moves in Ireland, Gibraltar, Holland and Belgium were also noted.
Among the issues being examined by the European Court of Justice, they wrote, was whether "the establishment of subsidiaries in another member state solely because of a more favorable tax regime in that member state is an exercise of the EU freedoms or an abuse of those freedoms."
To a lot of people worried about incentive policy in the U.S., such statements have an eerily familiar sound. Whether it's freedom ringing remains to be seen.
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