Luxembourg is a relatively tiny country located in Western Europe with a population of approximately half a million people in an area of 2,586 square kilometers. Luxembourg’s neighboring countries are Germany, France and Belgium.

Luxembourg is a well developed rich country. Its economy can be characterized as stable, generating high-incomes and having low rates of inflation and unemployment. Luxembourg’s GDP per capita constituted 102,284 US dollars, 22% being a direct result of the offshore banking Luxembourg and financial sectors.

The development of offshore banking Luxembourg is substantial. This can be explained on the one hand on the basis of the existence of a stable economic environment and on the other hand on the basis of the availability of favorable regulations which provide for various legal regimes that directly serve as a luring incentive for the creation and operation of the offshore banking. And of course such factors as the growth of the Euromarkets and the Luxembourg Stock Exchange on which the majority of Eurobonds are listed play a crucial role. Luxembourg’s share of the worldwide offshore banking wealth is approximately estimated at 6%-8% and can be definitely labeled as a large one.

According to KPMG’s “Luxembourg Banks Insights 2008” report in 2007 there were about 156 banks in Luxembourg including both local and foreign banks. Their total assets constituted in the same year EUR 915 billion. Thus, Luxembourg is the largest private banking country in Europe and is the second largest banking jurisdiction in Europe behind only the United Kingdom.

A big proportion of such a rapid growth of the offshore banking is namely due to the existence of the so called low tax or offshore activities. They can have different forms and structures. Though interestingly, the term offshore per se is not used in the national legislation. Offshore activities in Luxembourg usually presuppose a certain form of holding company and subsequently the obtainment of the offshore tax treatment. Therefore, the offshore activities are possible only through the different forms of holding company and collective investment fund. In addition, they are limited to a particular holding and financial activities for which they were originally created. In contrast, all other categories of business activities have to be conducted in the general stream of the economy and are actually highly-taxed.

In Luxembourg there are several statutes that regulate the operation of holding companies. However, this legislation was changed due to a 2007 decision of the European Commission, according to which they violated EC Treaty state aid rules by granting “unjustified tax advantages”. It has to be noted that this EU initiative affected directly Luxembourg. As a result the holding forms of company were abolished. The relevant domestic implementing legislation state that the holding companies which were created before the entrance into force of the relevant piece of legislation will be entitled to continue benefiting from their current tax regime until 31 of December 2010.

It has to be noted that offshore banking in Luxembourg faced other several challenges. Namely, the European Union on 3 of June 2003 adopted the Savings Tax Directive subsequently amended by European Commission on 13 November 2008. Under the Directive Luxembourg banks had to apply a withholding tax to the returns on the savings of the EU citizens, rather than providing information to the citizens’ home tax authorities. Originally the rate of the withholding tax was fixed at 15%. However, in 2004 after negotiations between Brussels and Switzerland more suitable rules were introduced regarding the imposition of a withholding tax and at the same time at the preservation of banking secrecy, which also apply to Luxembourg.

It has to be noted that Luxemburg’s offshore banking still remains very strong, notwithstanding the EU regulations. Taking into consideration that Luxembourg‘s banking assets constituted in 2007, EUR 915 billions, it doesn’t appear that the Directive at stake has had such a big effect.