04 October 2011

Financial Secrecy Index 2011: Focus on Luxembourg

Luxembourg accounts for slightly over 13 per cent of the global market for offshore financial services, making it a huge player compared with other secrecy jurisdictions.

Luxembourg is one of the world’s top secrecy jurisdictions. It works actively and aggressively to defend financial secrecy, in the face of European efforts to promote transparency. Its history as a financial centre stems from three main developments: first, tax-free facilities for non-resident corporations, dating from 1929; second, the emergence of offshore eurodollar and ‘eurobond’ activity in the 1960s, attracted by Luxembourg’s regulatory laxity and tax-free status; and third, tight secrecy rules, first enshrined in the Banking Law of 1981.

Underpinning the financial sector, as with its competitor Switzerland, is the country’s political stability, underpinned by its neutrality and bolstered by the fact that politics has been dominated for the past half-century by a right-wing political party, the Chrëschtlesch Sozial Vollekspartei (CSV) which has strongly supported financial secrecy and the financial centre.

Luxembourg has historically offered a wide range of international and offshore services, particularly banking, fund administration, global custody services and hosting holding companies. It is the world’s second largest mutual fund market after the US, with over 3,700 registered funds holding €2.2 trillion in assets in June 2011; it is the biggest private banking centre in the eurozone and the biggest captive reinsurance market in the European Union; and the Luxembourg stock exchange is the biggest in Europe for the listing of international bonds, with over 40 per cent of the total.

Banking secrecy is based most importantly on the secrecy of professional lawyer-client relationships; however other forms of secrecy are provided. Currently the Luxembourg Bankers’ Association (ABBL) is lobbying for a new private foundation regime for philanthropic foundations that would allow founders “to access capital placed in a foundation” – a common secrecy and tax evasion facility – and to allow for the creation of trusts under Luxembourg law.

In 1929 Luxembourg took its first steps as an offshore financial centre, with a new regime for holding companies, under which multinational corporations could set up ‘holding company’ subsidiaries in Luxembourg (set up purely to own assets elsewhere) that would be exempt from income and capital gains tax.  Although justified as a way to help multinational corporations avoid getting taxed twice (once in their ‘home’ country and then again in the country where they were investing,), in reality they were used increasingly to achieve double non-taxation: that is, to escape tax in both countries.

The European Union has for some years been trying to boost financial transparency through its Savings Tax Directive, under which Member States (and other participants) automatically share information with each other on certain types of cross-border income, or withhold tax. The Directive is full of holes, but these are being tackled. Nearly all EU members have agreed to the gold standard of automatic information exchange, but EU members Luxembourg and Austria have refused. A complex political dance has emerged with Switzerland and Luxembourg allied in efforts to hold up further EU progress on transparency: Switzerland says it will not yield on secrecy unless Luxembourg and others do; meanwhile Luxembourg has cited recent bilateral Swiss deals with the UK and Germany, which politically undermine the Directive, as a reason for blocking further progress.

Next steps for Luxembourg

Luxembourg’s 68 per cent secrecy score shows that it must still make major progress in offering satisfactory financial transparency. If it wishes to play a full part in the modern financial community and to impede and deter illicit financial flows, including flows originating from tax evasion, aggressive tax avoidance practices, corrupt practices and criminal activities, it should take action on the points noted where it falls short of acceptable international standards.

Full report

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