McDonald's proposition was an audacious one to put to a taxman: there is “no requirement” for royalties from European franchises to be taxed anywhere in the world. Even more remarkably, Luxembourg accepted it, according to documents released from an EU probe.
The disclosure of McDonald’s secret exchanges with the Grand Duchy, made public on Tuesday by the European Commission, provides a glimpse into the kind of tax treaty arbitrage that has helped US multinationals stash away more than $2tn of untaxed profits since the 1990s.The commission investigation into McDonald’s arrangements with Luxembourg is emerging as an important legal test case for Europe and the US. The probe turns on whether the Grand Duchy failed to apply its own tax laws and thereby supported the restaurant chain with illegal state aid.
LUXEMBOURG PROSECUTORS SEEK JAIL TIME FOR WHISTLEBLOWERS ... CRY ME A RIVER
Prosecutors requested 18-months in prison for two French whistleblowers, Raphaël Halet and Antoine Deltour, former employees of the audit firm PricewaterhouseCoopers (PwC).
State prosecutor David Lentz, who acknowledged that the LuxLeaks revelations unveiled “certain dubious practices,” also requested an unspecified fine against French journalist Edouard Perrin, who first revealed the documents.
Perrin, whose ground-breaking work was later expanded through a global investigation by ICIJ, revealed how the tiny nation of Luxembourg had effectively become a tax haven, slashing tax bills by billions of dollars for multinational corporations through secret tax agreements. Companies to have benefited from the shadowy deals included IKEA, Disney and Skype.
The LuxLeaks investigation was cited in an official European Commission report as paving the way for a "fundamental change" in Europe's tax rules that requires member states to share details of tax agreements made with international corporations. Luxembourg’s own finance minister described the investigation as a “game changer.”
During the hearing, Deltour, who first leaked the documents before Halet followed, told the court, “I feel a certain pride in having contributed to these important advances to taxation in Europe.”
A lawyer representing investigative journalist and ICIJ member, Perrin, said, “my client has done only done one thing - reveal the truth", he said. "To condemn him would be immoral and contrary to our rights."
The court’s decision is expected in June.
Read more about the impact from ICIJ's investigations, and find out how you can support ICIJ's work
The probe strikes at the heart of the so-called “check-the-box” tax planning, where legal blind spots in international double-taxation treaties are used by some US multinationals to route profits to tax havens via “disregarded entities”. The US administration has harshly criticised the commission for unfairly targeting American companies that will eventually repatriate their profits.
The commission states that McDonald’s obtained two tax rulings — letters clarifying tax obligations — from Luxembourg in 2009 that ensured that it paid no corporate tax on the profits of McDonald’s Europe Franchising, which were more than €250m in 2013. This entity received royalty payments for know-how and branding from restaurants in Europe and Russia.
In the first tax ruling, Luxembourg granted a tax exemption to McDonald’s provided that it demonstrated on a yearly basis that its “profits have been declared and are subject to tax in . . . the US”.
However, McDonald’s returned to request a revision to the ruling, claiming that the US-Luxembourg tax treaty allowed for exemptions on income that “may” be taxed in the US. “There is . . . no requirement that the other contracting state (US) effectively taxes this income,” an adviser to McDonald’s wrote.
This written request was accepted by the Grand Duchy. It is a decision that the commission argues amounts to a “misapplication” of its tax treaty with the US and unlawful state aid. When launching the probe in December Margrethe Vestager, the EU competition commissioner, said: “The purpose of double taxation treaties between countries is to avoid double taxation — not to justify double non-taxation.”
The cases are highly contentious. Luc De Broe, a tax litigation partner at Laga, warned that the commission was in danger of overreaching to become Europe’s “tax police”. The McDonald’s case rested on a tax treaty interpretation “for which only a Luxembourgish tax judge would be competent”, he added.
Brussels has the power to force Luxembourg to recover unpaid taxes. Luxembourg rejects the accusation that it illegally favoured McDonald’s. The restaurant group also denies any wrongdoing.
US multinationals have made increasing use of Luxembourg as a low-tax bridgehead into Europe. The profits reported by US companies in Luxembourg rose from 18 per cent of its gross domestic product in 2004 to 127 per cent in 2010. Much of this profit has not been repatriated to the US, contributing to more than $2tn in lightly taxed foreign earnings being held outside the US.
While some of these earnings have been reinvested, Moody’s, the rating agency, has estimated there is $1.2tn cash in the stash of profits held overseas. The money will be taxed when it is eventually brought back to the US, but companies are delaying its return in the hope of a rate cut, as part of wider tax reform. US politicians, such as Kevin Brady, who chairs the House ways and means committee, have attacked the commission’s investigations as “a money grab targeted on US companies”.