World Class Faculty & Research / June 15, 2016

'Secret Sweetheart' Tax Deal Entangles McDonald's

SMITH BRAIN TRUST — The European Commission last week released details of its ongoing investigation of a Luxembourg-McDonald’s “sweetheart” tax deal and shined new light on “Europe’s new tax raid.” Regulators are focusing, in part, on Luxembourg as a tax haven. Previously, U.S. Treasury Secretary Jack Lew has blasted the process, saying that U.S. companies are disproportionately under attack.

The Luxembourg-McDonald’s deal gives a window to the complexity of interpreting and regulating cross-border tax rules and advance pricing arrangements, says finance professor Michael Faulkender at the University of Maryland’s Robert H. Smith School of Business.  While responsibility lies with governments to manage these processes, Faulkender says McDonald’s and other companies are acting dutifully to their shareholders by “arbitraging variation in tax laws and treaties.” And Lew’s assessment, if accurate, “results from the U.S. tax rate being so high that the greatest incentives to engage in these kinds of tax structures probably lie with U.S. companies,” Faulkender says.

Starting in 2009, Luxembourg officials secretly agreed with McDonalds that its European-franchise royalties would be tax exempt. The decisions collectively accounted for the U.S.-Luxembourg tax treaty (such pacts are designed to mitigate double taxation), while agreeing with the fast food giant that it does not have a permanent establishment in either country. Through the arrangement, McDonalds has avoided paying taxes on royalty profits, including $273 million in 2013, the commission says in validating its probe into whether Luxembourg is violating EU state aid policy by giving McDonalds competitive advantage.  Luxembourg counters that its deal is a mere interpretation of relevant provisions of its own law.

Tax deals are scrutinized differently within the United States, Faulkender adds for comparison. “The federal government does not have authority over states creating tax abatements or enterprise zones with reduced taxes to draw companies,” he says.

To what extent can the EU overrule its member-state’s legal findings? According to UK law firm Pinsent Masons, the European Commission has no direct authority over national direct tax systems. “However, it can investigate whether certain advantageous fiscal regimes would be prohibited under its state aid rules, which are intended to prevent the distortion of competition that occurs when national governments grant advantages or incentives to particular companies.”

Faulkender says the McDonalds-Luxembourg pact can be viewed similarly to the case involving the Netherlands challenging a commission order that Starbucks pay the country $32 million in owed taxes. The ruling concerns a “Double Irish with a Dutch Sandwich,” a tax avoidance technique that combines Irish and Dutch subsidiaries to shift profits to low or no tax jurisdictions. Faulkender says the deal reduced the coffee giant’s tax rate “to less than 1 percent, and through transfer pricing, affected most of its European operations.”

Faulkender warns that European Union efforts to force the likes of Starbucks and McDonalds to cough up more in taxes could lower U.S. tax revenue due to IRS credits for taxes paid abroad by U.S. corporations. “Europe’s recent crackdown is yet another example of why comprehensive reform that greatly simplifies the U.S. tax code is necessary — if lawmakers are truly interested in addressing income inequality and economic growth,” he says.

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About the University of Maryland's Robert H. Smith School of Business

The Robert H. Smith School of Business is an internationally recognized leader in management education and research. One of 12 colleges and schools at the University of Maryland, College Park, the Smith School offers undergraduate, full-time and flex MBA, executive MBA, online MBA, business master’s, PhD and executive education programs, as well as outreach services to the corporate community. The school offers its degree, custom and certification programs in learning locations in North America and Asia.

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