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Baxter World Trade S.A. has a difficult decision to make. The subsidiary of American medical supplier Baxter International Inc. has had a big branch office in Belgium for 20 years. But tax breaks for multinational companies doing business there are going to end or be significantly scaled back over the next few years. So Baxter must decide whether to stay put, at a much greater cost, or to find another home for its Belgian operations. We are “forced to reconsider our strategies,” says Rudy Van Steenbergen, vice president of Baxter’s tax operations in Europe. He expects the health care giant to split the difference. Baxter will keep its marketing, technology, tax, and legal support services in the 200-employee Brussels office. But the company is likely to relocate the subsidiary’s treasury and finance activities, and is considering Switzerland and Ireland as possible new homes for those workers. “Financial activities are pretty easy to move, because they don’t require an army of people,” Van Steenbergen explains. “Capital can move very freely everywhere. It’s not like a plant that has to be close to your customers.” Competition for that capital has grown increasingly fierce over the last decade, as European nations one-up each other with tax breaks and aid to foreign companies. The jockeying has caught the eye of European regulators who view these tactics as a threat to the common market. Mario Monti, first as the commissioner of the internal market and now as the commissioner for competition, has been at the vanguard of the movement to end these practices. He has waged war against E.U. countries’ unfair use of tax shelters and “state aid” for foreign businesses on two fronts � through legislation and litigation. And in early 2003, he won victories on both battlefields. CRACKING THE CODE It took years to get to this point. In 1997 Monti convinced the Economic and Financial Affairs Council, the treasury officials from the 15 E.U. nations, to take up the fight against “anticompetitive” tax policies. This group, known as ECOFIN, oversaw the development of a “Code of Conduct.” The code highlights 66 laws or practices in E.U. nations that could unduly influence a business’s decision to set up a base in a particular country. After debating the issue for four years, ECOFIN agreed to send the code to the full European Council this spring, which is expected to adopt it later this year. When that occurs, the states that are home to the 66 controversial tax plans will have to abolish or dramatically retool them. Impatient at ECOFIN’s delay, Monti and the European Commission, the E.U.’s enforcement branch, in 2001 began to separately investigate more than a dozen of the 66 tax plans � including measures in Belgium, the Netherlands, and Luxembourg. In February the E.C. declared that some of these questionable practices must end. “The decisions taken by the commission . . . herald the definitive end of these tax-breaks,” Monti said on February 18. “The commission’s action is a key element in the fight against harmful tax competition.” A GOOD FIGHT In the eyes of ECOFIN and the commission, the Benelux countries were among the worst offenders. Belgium, the Netherlands, and Luxembourg � three of the smallest E.U. states � practiced more than a quarter of the 66 tax measures that the code of conduct deemed “harmful.” Dramatically changing or eliminating these policies � which cut across a broad swath of business � will end billions of dollars of tax breaks and alter the tax landscape of Europe, especially the Benelux nations. Multinationals doing business in these countries must decide whether they can afford to stay there once these changes come into effect, or whether they should move to more business-friendly countries like Switzerland (which isn’t an E.U. member). “Corporate counsel are going to have to look at how the code of conduct affects” their companies’ European operations, says Howard Liebman, a tax partner in Jones Day’s Brussels office. The Benelux countries can’t afford to lose too many foreign companies. In 2000 U.S. direct investment was $16 billion in Belgium, $116 billion in the Netherlands, and $20 billion in Luxembourg, according to the U.S. Bureau of Economic Analysis. The policies under attack have been popular among foreign businesses for many years. They include: Belgium’s lavish tax breaks for multinationals with a regional office there, the Dutch practice of providing businesses with “certainty in advance” for projected tax burdens, and a Luxembourg law that allows many holding companies to be tax-exempt. The Benelux countries have put up a good fight. They are modifying their policies and hoping to win ECOFIN or commission approval for the watered-down versions. The Low Countries have also fought back in other ways. They’ve recently lowered their corporate tax rates, in an effort to retain foreign businesses. They’ve sent government officials on U.S. tours to promote the new policies to current and potential investors. Those officials tout the Benelux countries’ many attributes � their central location, distribution networks, multilingual workforce, and regulatory flexibility. But will that be enough to keep foreign companies from leaving? Belgium For more than two decades, Belgium has been a popular place to set up a European office. More than 480 multinational enterprises have established subsidiaries there � called “coordination centers” � since the government created this special tax structure in 1982. The businesses were lured by a favorable tax package that allows them to reduce their tax base significantly by excluding financial and personnel costs. The coordination centers are also exempt from withholding taxes on dividends and interest. These foreign offices are big business for the small country. In 2000, 276 coordination centers had $193 billion worth of assets. With head counts ranging from ten to several hundred, these subsidiaries currently employ about 8,500 people in a country of just 10 million. Jean-Yves Dopchie, who heads Forum 187, a trade group that represents the centers, says, “The coordination centers in Belgium are as important for Belgian employment as employment in the City of London is for the U.K.” Dopchie is concerned that with the centers’ tax breaks under attack, foreign businesses will move elsewhere. Regional general counsel at American-based corporations like International Paper Company and Honeywell Inc. are still mulling their options. Relocating “is not something that would be done lightly,” says George Van Kula, Honeywell’s GC for Europe, the Middle East, and Africa. But The Procter & Gamble Company, which employs several hundred people at Brussels’s largest coordination center, moved its main European operations to Geneva a few years ago. “Brussels was historically our European headquarters,” says Veronique Huysmans, P&G’s general counsel for the Benelux region. She describes the move as “mainly an organizational choice, though of course we looked at tax issues.” That may be the wave of the future. Some observers say the independent Swiss are siphoning off foreign subsidiaries. “We’ve already seen a major exodus [of some multinationals' financial activities] to Geneva and Zurich,” bemoans Patrick Kelley, a Brussels-based tax partner at Linklaters De Bandt. But Belgium has fought back. It is lobbying the European Commission for a less favorable tax scheme that will have the effect of keeping the coordination centers in business. The E.C. is expected to rule on the proposed revision later this year. In early 2003 Belgium also lowered its corporate tax rate from 40 percent to 34 percent. Those efforts may help placate foreign corporations. ExxonMobil Corporation established a Brussels base for its petroleum refinement and chemical divisions in the late 1990s. At this point the company isn’t planning to pull up its stakes, according to Thierry Cornu, a Belgian lawyer and regional tax manager for ExxonMobil in Europe, the Middle East, and Africa. He says there are other reasons for the oil behemoth to be in Brussels, including its proximity to Antwerp and Rotterdam. Those cities’ ports, two of the world’s busiest, connect with pipelines and extensive distribution links to the rest of Europe via rail, road, and barge. The Netherlands Nine Dutch fiscal measures made the code of conduct’s “harmful” list, more than twice that of any other country’s, a dubious distinction. The ECOFIN council and the European Commission specifically criticized Holland’s long-standing practice of providing potential investors with “certainty in advance” about their projected tax burden. These “rulings,” now called “advance pricing agreements” or APAs, forecast the taxation of new or changing corporate structures. To alleviate concerns about APAs, Holland has reworked the policy. It has added more restrictions and red tape to the process of applying for tax estimates. Fewer companies are receiving rulings, and those that do must now supply much more paperwork, especially for cross-border transactions. In addition, “paper” or “mailbox” companies that use the country solely for tax purposes and don’t actually do business there can no longer obtain advance certainty. But “as long as they have a good business case, companies can [still] get this ruling,” says Marlies Vermeulen, the Dutch tax lawyer in charge of Applied Materials, Inc.’s treasury and taxation for Europe. Even under the new rules, APAs are expected to remain in vogue. Wilma Lloyd-Schut, a Dutch lawyer who is the chief European counsel for the Houston-based Lyondell Chemical Company, says that favorable tax policies were one of the primary reasons Lyondell chose the Rotterdam area last year for two new chemical plants. The plants, which are expected to cost the company $1 billion, will be completed this summer. “Although the [tax] rules are strict, they’re based on cooperation and finding a resolution for a business. You know where you stand,” Lloyd-Schut says. She notes that Lyondell recently decided to move its official European headquarters from Maidenhead, England, to its Rotterdam office, which already has about 200 employees. Luxembourg For decades, Luxembourg, often called the “Delaware of Europe,” has been a popular place for foreign businesses to incorporate or to set up a base. “Luxembourg has gained a critical mass as a location for holding and finance companies,” says Roger Molitor, a partner with KPMG Tax Advisers in Luxembourg. In 2002 more than 14,500 holding companies were incorporated there under a business law that was enacted in 1929. The law has a strict definition of a holding company and prohibits these entities from conducting any industrial or commercial business with the public. In return, these “1929 holdings” are exempt from nearly all taxes. Not surprisingly, this tax shelter aroused the suspicion of ECOFIN, the commission, and other countries, which have denied it protection from double taxation under their treaties with Luxembourg � decreasing the structure’s popularity with foreign corporations in recent years. AOL Europe, for example, has stayed away from setting up these holding companies “because they’ve got an awful reputation,” says Richard Minor, an American tax lawyer who manages AOL Europe’s holding company in Luxembourg. “I’m not talking about criminal, just about form over substance.” Despite their image problems, these structures are still widely used. “The business activity of setting up holding companies and managing holding companies by lawyers, accounting firms, and banks [means] there is a big community that earns income on that,” says Sonja Linz of Deloitte & Touche’s Luxembourg office. The controversial policy will be phased out over the next seven years and end in 2010; ECOFIN granted this extension in January. The transition period will afford companies that rely on these tax shelters more time to restructure their businesses, says Olivier Martin. He is a tax specialist acting as of counsel at Brucher & Seimetz, the Luxembourg office of Philadelphia-based Dechert. To Martin, the code of conduct spells the end of an era: “We will not have companies that are not taxable. It’s over. It’s not acceptable to have generally tax-exempt companies anymore.” To deter corporations from going to more favorable countries when they set up their subsidiaries, Luxembourg is implementing a number of tax breaks. Last year the country lowered its corporate income tax from 37 percent to 30 percent, putting it on par with the U.K. and undercutting its closest competitors, Belgium and the Netherlands. That may help fend off deserters. AOL Europe, for example, expects to expand its office there in the next few years. “I’m definitely bullish on Luxembourg as an investment base for U.S. companies,” says Minor. He cites the country’s sophisticated multilingual workforce and e-commerce infrastructure. The low taxes and accommodating regulators really set Luxembourg apart, he says. “We wouldn’t have that access in other countries. There are so few industries here that they need to listen to the companies that are here.” Still with the loss of tax breaks like the 1929 holdings, other benefits may not be enough to keep some corporations from seeking shelter in Switzerland or offshore tax havens. “There will always be some country where you will have tax-free companies,” observes Deloitte & Touche’s Linz. Margery Gordon is a former Corporate Counsel reporter.

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