The “double-irish” Luxembourg style

The European Commission have announced that they are opening a state-aid investigation into Amazon’s tax affairs in Luxembourg.  Once again the focus is transfer pricing.  However, the description of Amazon’s tax structure in Luxembourg has a familiar ring.  Here is an extract from the statement by Commissioner Almunia:

The ruling we are looking at concerns Amazon's subsidiary in Luxembourg, which records most of the group's European profits. This company pays a royalty to another entity based in Luxembourg, but not subject to corporate taxation in Luxembourg. Today we observe that through this mechanism most European profits of Amazon are recorded in Luxembourg but are not taxed there. The terms for calculating this royalty are essential. These transfer pricing arrangements are set out in the ruling of 2003 that is the focus of this investigation.

At this stage we consider that the amount of this royalty, which has lowered the taxable profits of Amazon, might not be in line with market conditions.

Or as slightly more technically put in the formal statement:

The tax ruling in favour of Amazon under investigation dates back to 2003 and is still in force. It applies to Amazon's subsidiary Amazon EU Sàrl, which is based in Luxembourg and records most of Amazon's European profits. Based on a methodology set by the tax ruling, Amazon EU Sàrl pays a tax deductible royalty to a limited liability partnership established in Luxembourg but which is not subject to corporate taxation in Luxembourg.  As a result, most European profits of Amazon are recorded in Luxembourg but are not taxed in Luxembourg.

So we have a trading company operating in Luxembourg that records the sales made by Amazon from across the EU - these number in the millions and thus accumulate a large profit.  But then the trading company makes a royalty payment to another Luxembourg-registered company but one that is not subject to tax in Luxembourg.  Thus the payments to the holding company are not taxable in Luxembourg.  These payments will be for the right to use the intangible assets (brand, technologies etc.) that Amazon has developed.  A good description of Amazon’s tax structure is in this 2012 article from Reuters, which has now being confirmed by the EU Commission.

This is very similar to the structure used by Google in Ireland.  Google has a trading company here that books almost all of Google’s advertising sales revenue outside the US.  This trading company makes a royalty payment to a non-resident Irish company which is “managed and controlled” in Bermuda. This is an intangible asset holding company.  A more complete description was provided in a recent IMF Fiscal Monitor (see page 47).

Amazon are essentially engaging in a “double-irish” but doing so in Luxembourg.

The European Commission is not investigating the overall nature of the structure, i.e. the two companies can comprise the “double” because that complies with existing tax laws.  The Commission is investigating the size of the royalty paid by the trading company to the holding company that has the intangible assets.  The question the Commission is setting is whether enough profit is declared by the trading company not whether the overall structure is illegal.

Of course, the whole point of using two companies incorporated in the same country (whether it is Ireland or Luxembourg or any country) is to avail of the “same-country exemption” in the US tax code.  The US taxes US companies on their worldwide income is Amazon, Google and the like are subject to the 35% US corporate income tax on their worldwide profits.  However, using the “same-country exemption” they can engineer a deferral on the payment of this US tax until the profit is repatriated to the US, if ever.

Google does it using two companies in Ireland; Amazon does it using two companies in Luxembourg and there are likely to be many other examples.  There is nothing Ireland or Luxembourg can do about the “same-country exemption” in US tax law.

The OECD is proposing to reduce the effectiveness of these schemes but trying to more forcibly link the location of profits with substance.  At present, these companies can locate the intangible assets in holding companies based in low- or no-tax jurisdictions such as Caribbean Island where there have little more than a brass-plate operation.

The OECD is proposing a DEMP solution to the problem.  The assets must be located close to the substance that either

• Developed,
• Enhanced,
• Maintained, or
• Protected

the intangible assets.  If a company does not engage in DEMP activities it cannot claim entitlement to the profits from holding the intangible assets.  The profits must be linked to the DEMP substance. 

At present these companies do not engage in DEMP activities in small Caribbean Islands but are locating they profit from their intangibles there.  The companies are benefitting from the zero taxation that these jurisdictions offer and they are using the “same-country exemption” to defer the US tax that is due on this assets.

Both the European Commission, and more importantly, the OECD are examining this issue.  However, they are not questioning the “two-company structure”; they are looking into the transfer pricing agreements between the companies. 

The European Commission are questioning whether more profit should be declared by the trading company while the OECD are proposing that the profit declared by the company holding the intangible asset must be linked to the substance behind the intangible asset.  If the OECD’s proposals come to the fruition they are likely to have a far greater effect.  Neither the Commission or the OECD have any jurisdiction over the “same-country exemption” in US tax law.  Nor over the “look-through rule” and “check-the-box” which can equally be used to engineer a deferral of US corporate income tax for US companies on their non-US profits.

There is nothing illegal or probably even questionable about the two company structure at the heart of the “double-irish”.  What we learned today is that Amazon has a similar two-company structure in place in Luxembourg.  But the “double-luxembourger” doesn’t have the same ring to it.

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