Luxembourg Tax Document Leak Leaves PwC and its Multinational Clients Vulnerable

On November 5 the International Consortium of Investigative Journalists (ICIJ) and its media partners released 28,000 Luxembourg tax ruling documents prepared by global audit firm PricewaterhouseCoopers (PwC) for 340 corporate clients – 548 comfort letters issued from 2002 to 2010 – and reported on their contents in stories that were published or broadcast all over the world.

I was quoted in one of the stories that was translated to several languages for media outlets in several countries, “Big 4 Audit Firms Play Big Role in Offshore Murk”.

“These firms are supposed to be built on honor and integrity and being a watchdog, but they’re so big now it’s all about making money,” says Francine McKenna, an accountant who has worked for PwC and KMPG and now writes a blog, re: The Auditors, about big accounting firms’ misbehavior. “They’re not worried about reputation, because all of this stuff has not affected their ability to get bigger and bigger and bigger.”

PwC, as you can imagine was on the defensive immediately. It’s a huge coup to have such a clear window into one tax haven and one firm — the top tax advisory firm according to PwC’s own horn-tooting.

Diana Henriques, the veteran New York Times reporter and author of the Bernie Madoff exposé “Wizard of Lies”, asked me via Twitter why I was focusing on PwC’s role.

I focus on PwC because its advice is essential to implementing the schemes. These complicated tax schemes — PwC says they are too complicated for journalists to understand — don’t just make themselves up.

I want to address two issues that PwC has raised in its own defense.

1. PwC claims that the Luxembourg documents were “stolen” by an employee and uses this claim to discredit the reporting.
2. Defenders of tax avoidance schemes say PwC’s advice was legal and PwC rejects “any suggestion that there is anything improper about the firm’s work.”

PwC provided comments to media and issued a press release to discredit the reports using the “shoot the messenger” strategy.

“The recent reports in the media on tax advice in Luxembourg coordinated by the International Consortium of Investigative Journalists (ICIJ) are based on partial, incomplete information dating back four years or more, which was illegally obtained. PwC takes the improper disclosure of any confidential information extremely seriously. As soon as it became aware that documents had been illegally taken from its offices in Luxembourg, PwC undertook a full investigation that quickly led to the individual who we believe took the documents. The matter was immediately reported to the relevant judicial authorities in Luxembourg whose enquiries into the matter are continuing. At the time of the disclosure of the documents, the individual had already left PwC’s employment.”

I asked Kelly McBride, Vice President of Academic Programs at journalism think tank The Poynter Institute and the co-editor of the book The New Ethics of Journalism: Principles for the 21st Century about the ethics of reporting on documents that may have been obtained by an employee who breached an employment or confidentiality agreement.

It seems maybe PwC is not familiar with how investigative journalists work.

“Lots of documents that journalists use may have been leaked/stolen/inappropriately obtained. The Pentagon Papers are the most famous example. However, especially when you are providing the source with anonymity, journalists have an obligation to make sure the documents are accurate, presented in a truthful context and not manipulated or otherwise faked. That may mean hiring forensic experts, corroborating the documents with extra reporting, and saying what you don’t know about the documents including how they were obtained.”

In this case there is also a “whistleblower” element because the public has a compelling interest in the contents of the documents and they might provide evidence of public corruption or other illegal activities. ICIJ, and any journalist who uses them, must make sure they are authentic. They did. In this case, the documents were filed with the Luxembourg government and are considered, as I understand it, to be public documents.

In a bit of irony, a US-based attorney for PwC warned ICIJ before publication on November 5 that further dissemination of the information would “violate money laundering, detention and concealment laws in Luxembourg”. Now that the documents have been posted, it will be interesting to see if PwC takes any further legal action to suppress them.

The second argument PwC and its defenders use to dismiss the ICIJ-led reports is that the advice provide by PwC is legal. We go back to PwC’s statement to understand its position.

“All our advice and assistance is given in accordance with applicable local, European and international tax laws and agreements and is guided by the PwC Global Tax Code of Conduct which has been in place since 2005. Our global tax code sets out guidance for our tax professionals around the world on a range of issues, including taking into consideration how any tax decisions will be viewed by wider stakeholders.”

In its statement to ICIJ, PwC uses a “complexity defense” to dismiss journalists’ allegations that the schemes were aggressive and potentially abusive. PwC said media do not have “a complete understanding of the structures involved.”

Richard J. Murphy of the Tax Justice Network in the UK put the “legal or not” issue to bed and takes journalist “pots” to task for hiding behind libel concerns to avoid calling the Big Four’s cauldron full of dodgy advice black.

“The LuxLeaks saw the inevitable riposte from the finance industry that industrial scale tax avoidance is “perfectly legal”. Accountants, so the theory goes, are simply taking advantage of the international rules which are decided by governments

The Guardian newspaper, which has led the charge on the tax avoidance issue in the UK, proclaims: “These arrangements, signed off by the Grand Duchy, are perfectly legal.”

Unfortunately, the situation is far from clear. Firstly the European Commission is currently investigating several tax agreements made between Luxembourg and multinational companies precisely to see if there is a case to be made that they contravene European competition policy.

To say something is “perfectly legal” is not a conclusion that anyone other than a judge can come to. The reality of these schemes are that they are typically bespoke and are dreamt up by people trying to test the boundaries of the law. Whether they trip up on the way has never really been tested.

In fact, aggressive tax avoidance schemes have a rather high failure rate. As Prem Sikka has pointed out, PwC said it will sell tax avoidance schemes that only have a 25% chance of surviving a legal challenge.

On top of that, Luxembourg is a secrecy jurisdiction – so if no one can ever see the deals, how can they challenge them? And how can their legality be tested? The very best we can do is say that we don’t know if the deals exposed by Luxembourg leaks are legal or not.”

The Prem Sikka column referred to above goes into more detail about PwC’s willingness to sell tax avoidance schemes that could have as high as a 75% chance of being deemed illegal by a tax court.

“Just before the hearing the committee received evidence from a former senior PwC employee stating that within the firm the policy was that it would sell a tax avoidance scheme that had only a 25% chance of withstanding a legal challenge.

As the committee chairperson put it “you are offering schemes to your clients – knowingly marketing these schemes – where you have judged there is a 75% risk of it then being deemed unlawful”. The other three firms happily admitted to “selling schemes that they consider only have a 50% chance of being upheld in court”.”

Sikka, a Professor of Accounting at the University of Essex, also gives examples of recent suits, sanctions and fines against all the Big Four firms for recommending tax avoidance schemes that were judged in the courts as tax evasion by their corporate clients.

PwC was slapped just last year:

“In May 2012, a BBC Panorama documentary showed how PwC devised schemes to enable multinational corporations, such as GlaxoSmithKline and Northern & Shell, to move profits to offshore tax havens via Luxembourg and avoid corporate taxes. A PwC inspired mass marketed tax scheme was struck out by the courts last year and HMRC said the scheme had “43 followers, with £87.7m of tax at stake”.”

PwC is also asking for big trouble from the SEC and PCAOB in the US by providing “novel and debatable tax strategies and products that involve income tax shelters and extensive off-shore partnerships or affiliates” to its own audit clients.

PwC audit clients make up a very large portion of the 340 Luxembourg tax advice clients on the ICIJ list. PwC must comply with US SEC auditor independence rules under the Sarbanes-Oxley Act of 2002 for US-listed audit clients.

PwC sold, and the audit committees approved, non-audit tax services for “transaction[s] initially recommended by the accountant, the sole business purpose of which may be tax avoidance and the tax treatment of which may be not supported in the Internal Revenue Code and related regulations.”

That’s prohibited by the Sarbanes-Oxley Act of 2002.

Shareholders for big names like AIG, GlaxoSmithKline, Heinz, International Flavors & Fragrances, Interpublic, Itau/Unibanco, JPMorgan, and Burberry paid PwC for audits that are supposed to be independent and objective but instead are tainted by an auditor blessing its own work.

For example, AIG, while owned by the US government after the largest of all the bailouts during the crisis, paid PwC more than 10% of an already inflated audit fee in 2008 and 2009 for what was described in proxies as “business as usual” tax preparation and consultation.

In a footnote to the SEC auditor independence rule, the SEC goes on to say:

The Commission on Public Trust and Private Enterprise recently concluded as a “best practice” that an accounting firm should not be providing “novel and debatable tax strategies and products that involve income tax shelters and extensive off-shore partnerships or affiliates” to audit clients. See The Conference Board Commission on Public Trust and Private Enterprise, Findings and Recommendations , January 9, 2003, p. 37.

In a 2009 presentation, PwC praises Luxembourg as a place with “flexible and welcoming authorities” who are “easily contactable” and offer a “readiness for dialogue and quick decision-making process.”

The main ICIJ LuxLeaks article highlights the advice PwC gave Amazon.

The commission argues that a generous 2003 tax ruling by Luxembourg authorities allows Amazon EU S.à.r.l. to funnel millions of euros in tax-deductible royalties each year to yet another Amazon company in Luxembourg, a limited partnership that is tax exempted. This tax break and others like it allow Amazon to pay little in taxes in the Grand Duchy on its European sales.

The leaked PwC documents show that in 2009 Amazon EU S.à.r.l. reported more than €519 million in royalty expenses while the limited partnership Amazon Europe Holding Technologies SCS had an influx of the same amount “based on agreements with affiliated companies.” Thanks to the royalty expenses and other deductions, Amazon EU S.à.r.l. posted a taxable profit of just €14.8 million and paid €4.1 million in taxes in Luxembourg.

Amazon is about to find out if the US is as friendly as Luxembourg has been. The company is in tax court right now in Seattle fighting IRS allegations that its Luxembourg scheme, designed, marketed, and implemented by PwC, is too aggressive and very illegal.