Why telcos love Luxembourg

Citation

Curwen, P. and Whalley, J. (2014), "Why telcos love Luxembourg", info, Vol. 16 No. 5. https://doi.org/10.1108/info-06-2014-0023

Why telcos love Luxembourg

Article Type: Rearview From: info, Volume 16, Issue 5

A regular column on the information industries

For a typical reader the matter will be clear-cut. Tax avoidance means taking advantage of the (often very complicated) provisions of a tax code to minimise a tax bill, and it is perfectly legal. Tax evasion, in contrast, means that taxable income is not being declared and, hence, it is illegal. However, in recent times, tax authorities around the world have begun to enunciate more forcibly the principle of “aggressive” tax avoidance, whereby the rules are technically being followed but because the outcome is in some manner unacceptably different from that intended – that is, tax receipts are too low in relation to revenues – remedial action is deemed to be justified.

For obvious reasons, because the sums involved are so large, disputes involving companies that revolve around the issue of “aggression” often end up being resolved in the courts of law. In the case both of telcos and others in the broader technology, media and telecommunications (TMT) sector, these disputes typically concern the issue of where in the world a tax liability is being generated. In May 2014, for example, it was noted that Amazon’s corporation tax bill for 2013 in the UK amounted to £10 million on a turnover of $4.3 billion. It was revealed that this was because Amazon reported most of its European profits via a tax-exempt Luxembourg partnership. Needless to say, Amazon’s defence was to the effect that it paid all applicable taxes in jurisdictions where it operated and that it had an obligation to its shareholders to minimise its tax bill by all legal means open to it.

This defence is also the fall-back position for telcos which themselves seem curiously fond of Luxembourg. The Vodafone Group is an interesting case in point since it has been involved in lengthy tax disputes in the UK, Germany and India. The root of the matter in the case of Europe is that the Vodafone Group operates through three primary holding companies of which two involve worldwide networks and are based in The Netherlands, while the third involves exclusively European businesses and is based in Luxembourg.

The UK tax authorities have been pursuing Vodafone Group’s “aggressive” tax avoidance since 2002, when they initially took umbrage at the €178 billion takeover of Germany’s Mannesmann having been conducted by a Luxembourg-based holding company to minimise tax. Under pressure to pay more tax in the UK, Vodafone Group successfully challenged the UK legislation designed to prevent companies diverting their profits to other countries, with the High Court ruling, inter alia, that European Union (EU) regulations effectively restricted the ability of one member state’s tax authority to enforce its own rules.

In 2009, the UK tax authorities succeeded in having the High Court decision struck down, but that merely triggered a bout of negotiations to determine how much tax should be paid. As recent media reports have made clear, the UK tax authorities usually settle for much less than is technically owed to forestall a further round of court cases. In this case, the sum outstanding was alleged to be as high as $6 billion, the sum set aside by Vodafone Group was in the region of £2 billion and the amount paid was £1.25 billion (which meanwhile had been earning interest in the bank). On the whole, a good outcome for Vodafone Group but at least some tax was eventually paid. No doubt the tax authorities in other EU countries were paying close attention, but in reality there is always the risk that a dispute will trigger a seemingly endless round of appeals as is normal in, for example, Italy, so a compromise is generally in everyone’s interests.

This is clear when one examines another tax issue which has involved telcos since the turn of the millennium and relates to the use of write-offs to minimise tax liabilities. At that time, telcos were buying assets at what proved retrospectively to be hugely over-inflated prices. The valuation placed on Mannesmann by Vodafone Group is an obvious case in point. Indeed, in 2005, Vodafone Group sought to write-off against tax an astonishing £36.7 billion of its outlay. The German tax authority, effectively recognising that as a consequence Vodafone Group would pay no corporation tax for the indefinite future, initially declined to make any kind of allowances. However, by 2009, with the total write-offs now standing at £46.7 billion, it eventually conceded a staggering write-off of £13.5 billion which was accepted.

Since the end of 2002, asset prices had returned to the levels prevailing in 1997, subsequent purchases were unsurprisingly undertaken at conservative valuations which suggested that they would not lead to further write-offs. However, the difficulties faced by telcos in Europe since the financial meltdown, driven by a toxic combination of economic recession, saturated markets, fierce competition and tough regulation, mean that write-offs are once again on the agenda – for example, Telecom Italia, wrote down the value of its domestic telecommunications operations by €2.2 billion in 2013, whereas in September 2013, as part of the sale of E-Plus in Germany to Telefónica, KPN agreed with the tax authority in The Netherlands that it will be able to deduct against future taxes a loss of €3.7 billion generated by the sale. What this means in practice is that for many years to come, KPN could end up paying a lot less tax than it previously did.

Naturally, telcos do not love only Luxembourg. For example, at the end of May 2014, Deutsche Telekom was alleged to have agreed to the sale of 67 per cent of its stake in T-Mobile USA to Sprint (acting as a proxy for Softbank). It was noted that earlier in the year Deutsche Telekom had shifted the holding company of which T-Mobile USA is a subsidiary from Germany to The Netherlands to reduce the tax bill should the sale go through. The German tax authorities will inevitably see such a move as “aggressive” tax avoidance, but how far will they be willing to go to recover tax, one wonders, in respect of a de facto national champion.

One somewhat worrying aspect of the above is that if disputes become entrenched, then the government in question may resort to retrospective legislation. This may never happen in Europe but it has already happened in Asia. For example, when Vodafone Group bought Hutch Essar in 2007, it used one of its Netherlands-based holding companies to buy from another company that was also based outside India in the Cayman Islands. No capital gains tax was forthcoming and, as ever, the case was dragged through the courts as the Indian tax authorities sought validation for their claim that the transaction was domestic and hence subject to tax in India. After the Supreme Court finally ruled in favour of the Vodafone Group in 2012, the government retrospectively changed the tax laws to encompass takeovers conducted outside India but involving Indian companies. It has to be said that there is limited enthusiasm for the new laws even within the government, but Vodafone Group was duly presented with its tax bill in 2013 and negotiations have yet to resolve the matter.

At the end of the day, the tax authorities have three options: negotiate a compromise, go to court or change the rules (possibly retrospectively). All are likely to be long-winded affairs and result in outcomes rather more favourable to the targets than to themselves. Furthermore, even within the EU, it is very evident that there is something akin to competing tax regimes despite the attempt to suggest that harmonisation largely prevails. Luxembourg and The Netherlands, and, indeed, Ireland, are not unduly concerned with the consequences of under-cutting their fellow member states. Although the UK has recently reduced its corporation tax, in part, to reduce the incentive for companies to base their operations elsewhere in Europe, it has also sought to name and shame. This adverse response is broadly based, with politicians joining media commentators and private protestors, to comment on the tax affairs of many (leading) companies. Unfortunately, although the likes of Amazon, Google and Vodafone Group have, as a, consequence faced a hostile reception and suffered some damage to their reputations, they know that they have the support of most of their shareholders and that they will continue to be used by the vast majority of their existing customers, so voluntary increases in the share of profits declared in high-tax countries where revenues are earned are likely to be little more than token gestures.

Peter Curwen and Jason Whalley

About the authors

Peter Curwen is a Visiting Professor and Jason Whalley is a Professor, both are based at Newcastle Business School, Northumbria University, Newcastle upon Tyne, UK. Peter Curwen can be contacted at: mailto:pjcurwen@hotmail.com