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The magical fairyland of Luxembourg

The “magical fairyland” of Luxembourg

Small, secretive and trilingual, the Grand Duchy of Luxembourg has punched above its weight for more than a thousand years

But Where is Luxembourg?

Where the bottom right-hand corner of Belgium ought to be: a nub of wooded, rolling European farmland that also has borders with France and Germany. The Grand Duchy covers 999 square miles (it is 55 miles long by 35 wide) and has a population of half a million, of whom 100,000 or so live in the capital, also called Luxembourg (or Lëtzebuerg in Luxembourgish). For more than 1,000 years, the territory has existed as a power broker in the heart of Western Europe. Three out of four of its last prime ministers – including the current president of the European Commission, Jean-Claude Juncker – have gone on to hold top jobs at the EU and UN. It’s also one of the world’s financial centres. All this, despite its tiny size and what The New York Times calls “the apparently unfixable fact that it’s rather boring”.

Why was Luxembourg never conquered?

It was. Many times. It dates its history to 963, when a Count Siegfried, rumoured to have married a mermaid, bought a rocky promontory and fort from a monastery in Trier. The stronghold was called Lucilinburhuc, old high German for “small castle”. In the Middle Ages, the princes of Luxembourg married, warred and schemed: four became Holy Roman Emperors; four, kings of Bohemia. John the Blind was famed across Europe for insisting on fighting the English at the Battle of Crécy in 1346 even though he couldn’t see. (He was killed.) From the 15th century on, Luxembourg was often conquered and traded, swapping hands between the Burgundians, French, Hapsburgs and Napoleon.

How did Luxembourg stay intact?

It almost didn’t. The Grand Duchy was four times its present size in the 17th century, before various invasions and treaties lopped off 75% of its territory. It only survived as an independent entity because it wasn’t important enough to start a war over. In 1867, the “Luxembourg Crisis” (King William of the Netherlands agreed to sell the territory to Napoleon III of France for five million guilders, but Bismarck, of Prussia, objected) ended at a peace conference in London, where the great European powers decided no one should have the territory. Instead, it would be “perpetually neutral”. Its fortress and walls were dismantled. The Grand Duchy began to reinvent itself as the peaceful, European crossroads it is today. Its laws are in French, but press articles are in German. (Luxembourgish is a mix of the two: “thank you” is merci, “welcome” is wëllkomm.)

Why is it so rich?

In the 19th century, it was found to be full of iron ore. (Steelmaking contributed 21% of Luxembourg’s GDP as late as 1974.) But the real reason the Grand Duchy has thrived is because of its long-standing ability to respond to the activities of its neighbours. With the exception of the two World Wars – when it was occupied both times, with harsh consequences, by Germany – Luxembourg has skilfully surfed the political and economic waves around it. In 1952, the European Coal and Steel Community, forerunner of the EU, chose the territory to be its provisional headquarters: it has been one of the bloc’s capitals ever since. Some 8,000 EU officials work in the city, in the European Court of Justice and a bevy of smaller institutions. Savvy politically, Luxembourg has been even sharper when it comes to money and banking.

How did the Grand Duchy do that?

Its development as a banking centre is usually dated to 1922, when it entered a monetary union with Belgium, but kept control of its (low) taxes. The train from Brussels to Luxembourg was nicknamed the “Coupon Express” for the Belgian professionals who’d board it to go and do business in the city. In the 1960s, it benefited similarly from the high taxes and tough banking regulations in Germany. Billions of Deutschmarks moved “offshore” there. The number of banks rose from 17 in 1960 to 218 in 1994; the weight of numbers and skilled staff meant it became a place where new financial products like eurobonds were invented and administered. (Eurobonds enabled European firms to sell bonds to investors from around the world in whatever currency they chose.) Luxembourg is “a truly unique financial services centre”, as accounting firm PwC puts it.

Is that a euphemism for tax haven?

Luxembourgers angrily reject the idea; and it’s true, their personal and business tax rates are comparable with the rest of Europe’s (at 29.2%, their corporate tax rate is higher than the UK’s). But there are crucial exceptions – low VAT, for example, the reason Amazon bases its European operations there. The real attraction for businesses and banks, however, isn’t low tax rates, but a host of subtle Luxembourgish technicalities, exemptions and rules – many decades old – that, once exploited on a grand scale, can save them billions of pounds (see box). These accounting oddities, combined with a strong tradition of secrecy in a vulnerable city, have made Luxembourg “a magical fairyland” to big corporations, in the words of Harvard Law School’s Stephen E. Shay.

Will it ever change?

Luxembourg’s motto is: “Mir wëlle bleiwe, wat mir sin” (“We want to stay what we are”). After 1,000 years of unlikely survival, the Grand Duchy feels it has carved out an incredibly successful niche, offering services the whole world wants to use. (Luxembourgers, after Qataris, are the richest people on Earth.) “It is not our fault if other countries tax their people more than ours,” says Nicolas Mackel of Luxembourg for Finance, which encourages investment into the territory. But it may have little choice, says the FT: “the paradox of a country at the heart of the single market that undermines its neighbours through the design of its tax system looks increasingly untenable”. The European Commission is investigating hundreds of alleged “sweetheart” deals offered to big firms and is suing Luxembourg so it will raise its VAT rate. The Grand Duchy has promised reform by 2017.

“The Luxembourgish Problem”

Many of the accounting tricks that enable hundreds of companies to save billions in taxes by basing their financial operations in Luxembourg are an accident of history, of old rules being put to new uses. One example is an unusual tax break, introduced during the Nazi occupation of the Grand Duchy in WWII. This rule, which has since disappeared in Germany, allows companies to reduce their tax bill if an asset that they own has fallen in value. For example, if firm A buys firm B and it turns out to have been a bad idea, then firm A can offset that loss against their taxes. (In almost every country in the world, companies simply have to accept their losses, and don’t get any tax relief for them.) By basing their finances in Luxembourg, this rule allows global companies to gather all their losses in one place and generate massive tax savings, which they can then use to reduce taxes against their profits. According to a Reuters investigation, Vodafone has used this anomaly to pay just €100m of tax in Luxembourg since 2001, compared to a bill of closer to €9bn – that’s 90 times more tax – if it had been forced to account for its profits under British rules.

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