Sunday, July 23, 2006

Cutting off Luxembourg's nose to spite the EU's face



Luxembourg is famous in the tax planning world for having "holding company" regimes. These reduce both withholding taxes on dividends and allow investors to sell their underlying investments tax-free. Consequently, a huge proportion of new capital, especially US capital, enters Europe via Luxembourg, as these entities enable overseas investors to increase their post-tax return on the capital invested in their Continental operations.

Step forward the European Commission which has now ruled that these are a form of unacceptable State Aid and is forcing Luxembourg to change its rules. Its another case of the Commission opening its tax harmonisation mouth before engaging its business brain. Virtually all the capital that went into these entities was ultimately invested elsewhere in Europe. UK, Italy, France, Spain and Germany are already among the highest taxers, based on marginal rates, of business income in the developed world. The sense then of the Commission removing this tax benefit for overseas investors is to make Europe an even a less attractive place for overseas, and notably US investors. Yet again the Commission is harmonising taxes up when the higher-growth parts of the world are pushing them down.

This does raise one curious question. If this benefit goes, and given that the EU Savings Directive was never great news for Luxembourg, then what's the benefit for Luxembourg of staying in the EU. Its got quite a lot to gain from moving to a Swiss or Norwegian style status and retaining rights over its domestic tax laws.

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