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EU moves to close the tax loophole for multinationals

European Union flags fly at the entrance of the European Commission headquarters in Brussels, Belgium September 29, 2015.
Yves Herman | Reuters
European Union flags fly at the entrance of the European Commission headquarters in Brussels, Belgium September 29, 2015.

U.S. companies seeking a favorable tax regime in Europe should now have second thoughts. On Tuesday, European Union finance ministers achieved a unanimous agreement on the automatic exchange of information on cross-border tax rulings. This agreement will enable EU member states to detect certain abusive tax practices by companies and take the necessary action in response.

For years Luxembourg, Ireland, The Netherlands and Belgium have offered U.S. companies the chance to reduce their tax burden to next to nothing through extremely lax legislation called tax rulings. Those rulings are comfort letters by tax authorities giving a specific company clarity on how its corporate tax will be calculated. Tax rulings are used in particular to confirm transfer-pricing arrangements, which are the prices charged for commercial transactions between various parts of the same group of companies.

Multinational companies have long been in the sights of European Union authorities because of the way they can legally reduce their bills by basing themselves in low-tax centers. The EU is already investigating the tax arrangements of Amazon and Fiat in Luxembourg, Apple in Ireland and Starbucks in the Netherlands and may start new investigations. Today's agreement will facilitate this effort.

The decision taken today by the EU Economic and Financial Affairs Council (ECOFIN) will enable EU member states in 2017 to have the information they need to protect their tax bases and effectively target companies that try to escape paying their fair share of taxes.

Read MoreTrouble brews for Starbucks, Apple as Europe takes aim at taxes

But to do this effectively, the 28 EU member states will have to transpose the new European rules into national law before the end of 2016 so it will come into effect on Jan. 1, 2017. When it does, the new EU directive for the automatic exchange of information on cross-border tax rulings will remove European countries' discretion to decide on what information is shared, and when and with whom. These developments are likely to bring into focus U.S. companies that have used the favorable tax rules in the recent past to pay minimum taxes.

"The automatic exchange of information on tax rulings will provide national authorities with insight on aggressive tax planning. It marks a leap forward in our efforts to advance on tax coordination and tax harmonization. The current system of corporate tax rules is unjust and unfit for purpose. There is a plethora of national rules that allows some companies to win while others lose out. This unfair competition is anathema to the principles of fair competition within our internal market," said Jean-Claude Juncker, president of the European Commission and former prime minister of Luxembourg. Juncker has been criticized for the tax model of the Grand Duchy.


For multinationals, there is a positive wrinkle in the new tax proposal. The EU finance ministers decided to reduce the retroactive application on existing cross-border tax rulings cases from 10 to five years. As a consequence of this movement, possible tax claims by the member states will be reduced considerably.

European Parliament is vehemently opposed to this. Alain Lamassoure, European Parliament's Tax Rulings Committee chairman, has already called the proposal to limit retroactive application to five years "absurd."

Read MoreAmazon in trouble over tax ... again

The limited retroactivity should favor companies like Amazon. Last October, the European Commission formally launched an investigation into whether Amazon received a favorable transfer-pricing-related tax ruling that violates EU state aid rules. The investigation focuses on a tax ruling granted by the Luxembourg government in 2003 to Amazon EU Sarl, a subsidiary that records most of Amazon's European profits.

Under the ruling — which is still in force — Amazon's trading company in Europe, EU Sarl, pays a tax-deductible royalty to a limited liability partnership set up in Luxembourg. But the LLP is not subject to corporate taxation in the Grand Duchy. So the tax arrangement enables most of Amazon's European profits to be booked in Luxembourg but go untaxed.

The goal is to tightly close the tax evasion window by 2017. One of the provisions of the new agreement is that tax rulings will have to be exchanged every six months. In addition, the EU Commission will regularly receive the information it needs in order to monitor the implementation of the new directive and ensure that member states are complying with their responsibilities. Under the weight of these developments, it's expected that many U.S. multinationals will soon review their tax strategy on the Continent.

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—By Nasos Koukakis, special to CNBC.com