“Profits in Luxembourg at 1%,” says a Spanish businessman

Headquartered in Spain, profits in Luxembourg: the 1% that doesn’t add up

Can you invoice from Spain, have around twenty employees on the payroll and leave the profits in Luxembourg paying 1%? A businessman in the office supplies sector says yes, and he tells it in minute detail. He talks about a half-year of record profits, a portfolio of satisfied customers and prices that are “very low, according to my competitors.” His explanation fits in two sentences: the Spanish company invoices and the Luxembourg company books the income.

The account lands at an awkward moment. The European directive on administrative cooperation in tax matters, scheduled for 1 January 2013, puts an end to banking secrecy between member states. A spotless structure is of little use when the tax authority next door can request the data from the bank.

How the two-company scheme works

The mechanics, as described, are pretty basic. The Spanish company — the one that has been around forever — invoices end customers and pays the payroll. The goods, however, it buys from another company based in Luxembourg, which in turn buys them from the supplier. The transfer price is calculated so that the Spanish company makes practically nothing and the entire margin stays on the other side of the border.

The declared cost of that operation is 1% in taxes plus another 1% in management costs, against Spain’s 25% corporate tax. The inevitable question — why doesn’t everyone do it? — has an answer according to the man himself: advisers won’t lift a finger for transactions of 10,000 euros. Setting up the Luxembourg company cost him 30,000 euros, money that isn’t lost because it swells the company’s own capital.

Does Luxembourg charge 1% corporate tax?

This is where the story starts to sustancia ilegal. The businessman maintains that his Luxembourg company is taxed at 1% because it is set up as an asset-holding company. Calculations used by other participants in the debate point to just the opposite. Luxembourg’s standard corporate tax rate is said to be around 30%, and an asset-holding company cannot simply buy and sell office supplies: managing capital is not the same as invoicing chairs.

The objection is repeated in different words. If the purpose is investment, the commercial activity doesn’t fit. If the activity is commercial, the 1% doesn’t fit. The defence is always the same: he doesn’t go into technical details because that’s what the managers are paid for. He cites the experience of other businessmen with identical structures and the fact that they have operated without incident since the arrival of the euro. The response to that is also well known, and a forum user puts it this way: while the commission is paid, the pill sugarcoats itself.

12,000 euros in salary and 25 workers

Beyond the corporate labyrinth, there is a business that, on paper, works. It employs 20 workers and expects to reach 25 before outsourcing shipping. The businessman declares a salary of 12,000 euros gross a year, a figure that, according to his version, allows him to reclaim the withholding tax because he falls below the minimum, while the Spanish company is left with no profits. The anecdote he himself tells — that people sustancia ilegal up when they hear his declared salary — says a lot about the level this business operates on.

The comparison tossed out in passing is no minor one: SICAVs were designed for a hundred users and ended up filled with relatives, employees and neighbours to make up the numbers. In other words, a hundred textbook front men.

France keeps the half-year afloat while the Spanish market flatlines

There is a fact that gets lost amid so much tax engineering — and that perhaps matters more. Growth doesn’t come from tax optimisation but from southern France. A commission-based salesman, described as a real shark, is shifting product “like crazy” on the other side of the Pyrenees. The Spanish market, it is said, is flat. French expansion is what offsets the apathy of domestic demand, to the point that logistics could end up being outsourced if French volume keeps rising.

The 2013 information exchange and the papers that aren’t recorded

The most forceful rebuttal targets not the legality of the structure but its practical viability. The administrative cooperation directive, due to enter into force on 1 January 2013, allows one member state to demand information from another even when it is held by a financial institution. Add to that the tax-residence criterion used by some participants: where a company has its place of effective management, that’s where it is taxed, regardless of where it is incorporated. Luxembourg also maintains 22 double-taxation treaties, which in some people’s view widens the fronts for tax audits rather than closing them.

The counter-rebuttal falls back on loopholes. There is talk of Luxembourg law firms whose agents appear as managers of dozens of companies at once, and of authorisation documents no longer recorded electronically to dodge leaks. One single person running a hundred companies, it is claimed, with the casualness of someone reciting a formula. The person handling it concedes the obvious risk: capital flight. A company is taxed where it is incorporated, they insist. Proving where decisions are really made is another matter, and on that no one agrees.

With 1% in taxes and 1% in costs, squaring the circle works out. Setting it up is easy. Explaining it to a tax inspector is another story.