LuxLeaks: tax exposure not the issue

At the beginning of both November and December, the International Consortium of Investigative Journalists (ICIJ) published two sets of documents outlining confidential Luxembourg tax structures of more than 370 companies, including a raft of private equity firms.

The online database compiled by ICIJ contains more than 550 official tax rulings by Luxembourg's authorities, with the hoard of documents having been unlawfully procured by ICIJ from the Big Four.

While the mega corporates detailed in the database bore the brunt of the media's outrage, private equity firms are still gaining mention in several reports on the LuxLeaks 'scandal'.

But for Gérard Neiens – a tax partner in the Luxembourg office of Hogan Lovells – "scandal" is the wrong word to use. "From our perspective, the so-called tax rulings are something rather usual and it's actually part of our business activity," he says. "There is a marked difference in reactions between the 'outside and inside' worlds. To those working in this industry, these tax rulings are just something offered in most EU member states. The outside world, which does not deal with tax affairs of multinational companies, is under the impression that all of these big firms are trying to avoid their tax demands."

Par for the course
"Some of these rulings offered by EU member states – as much Luxembourg as others – may potentially include some unfair aid in terms of advantages that could not be considered in line with arm's length standards," he admits, "but those rulings are, in my opinion, fairly rare – at least in the legal sector in which I work."

Interestingly, the revealed tax structures were not the bone of contention for many firms when the database went live, says Neiens. "When LuxLeaks came out, we approached our private equity clients to explain what had happened and to say that we could internally help or advise," he says.

"I was astonished – in a positive way – that clients were being quite easy-going about it. This is because they had done nothing illegal and they knew that the tax rulings do not deal generally with prohibited tax structuring or criminal tax avoidance.

"What they were unhappy about, however, is that the actual transactions – with their underlying financial models and commercial strategies – were made public, and that their sometimes entire worldwide structure charts, often annexed to the tax rulings, were published," he says.

Neiens goes on to note that these structures are used in 22 countries across the EU – in no way do they make Luxembourg unique. However, ICIJ's compilation of documents gives the impression that Luxembourg is the main target, because of the wrong, longstanding public notion that Luxembourg is the place where multinationals go to apparently avoid tax.

In reality, the reasons for the investigations that resulted in the culmination of LuxLeaks most likely boil down to the fact that ICIJ was able to obtain such a large number of documents specifically on Luxembourg tax structures.

"There are other countries, most notably the Netherlands and Ireland, that are typically used by the private equity industry to put in place these kinds of structures," says Neiens. "It's not just Luxembourg."

However, various components of Luxembourg's business environment do make it an attractive place for private equity firms to do this kind of business, due to the global nature of GPs' activities. "Generally, private equity firms carry out investments in multiple jurisdictions or have investors across several jurisdictions, which means you have to find a compromise in which everyone is comfortable," says Neiens. "You ought to have a structure that you are comfortable with now, but also in five years' time when an asset might be sold.

"In Luxembourg, you have legal certainty and stability in terms of economic parameters, and you also have regulatory, legal and tax environments which are investor friendly. Further, you wouldn't work through a country that doesn't have an extensive double tax treaty network as the risk of double taxation would be very high. So a country that has a deep double tax treaty network, such as Luxembourg, is of course a major advantage," he adds.

"Another major advantage for many private equity firms and investors is the possibility to further obtain a tax ruling – whose correct terminology is in fact advance tax agreement – as it provides predictability in terms of taxes to be paid throughout a certain limited period of time and thus of determining more accurately potential cash flow and profit calculations," says Neiens. "So a country that issues tax rulings has a major advantage: such issuance is not at all about tax avoidance, but about predictability and legal certainty in relation to taxes to be paid on certain operations, which gives comfort to investors and thus enables, or at least facilitates, their involvement and financial commitments to a given transaction."

The consequences of LuxLeaks currently look like a mixed bag of both positive and negative changes. With such a large leak coming from the Big Four, it is easy to wonder if some strain or trust issues may appear between GPs and service providers.

"I think one of the LuxLeaks consequences, besides a higher awareness of the existence of such tax rulings and hopefully their true underlying commercial reasoning and logic, is that the service providers – whether they are based in Luxembourg or somewhere else – will now be even more careful about how they grant access to their tax rulings, which may result in a slowdown in internal process dealings," says Neiens. "And to a certain extent, this caution may be a good thing in view of what has happened, as such rulings do often contain rather confidential information about a client in terms of business opportunities, structure schemes and commercial strategies."

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