Letterbox companies and the evasion of workers’ rights

Inclusive Economy10 Apr 2017Jan Cremers

Mainly known for their association with corporate and income tax evasion, letterbox companies have also been linked to dubious workers’ rights practices and social dumping in the EU. In the late 1990s, the term also started to be used in the international transport sector to describe companies that had an address in the country of establishment, but conducted all of their activities in a different jurisdiction. Today the phenomenon is spread over several sectors and is associated with a ‘cheap labour business model’: letterbox companies operating across borders pick and choose the most profitable social security and labour standards regime. The dubious and unlawful practices of these companies, which may seem perfectly legal on the surface, should be reviewed to protect workers, customers and genuine economic actors.

The notion of a letterbox company is quite simple. As defined by the Organisation for Economic Co-operation and Development (OECD), it is a business that establishes itself in a tax-friendly country with just the bare essentials required for organization (usually a mailing address), while conducting its commercial activities in other countries to minimize tax liabilities. This phenomenon can be seen as an unintended side-effect of the deregulation of company law.

Letterbox companies in the European Union

The association of letterbox companies with the free provision of services in the EU (where companies based in one member state are able to provide services in another) led to a definition that goes beyond taxation. As early as the debates on the EU Services Directive in 2004, critics of such uncontrolled mobility of national service providers referred to the creation of letterbox companies offering services at low prices. Interestingly, in 2013 the European Commission also referred to legislative loopholes in its description of letterbox companies, stating that they are “set up with the purpose of benefitting from legislative loopholes while not themselves providing any service to clients”. In other words, such companies do not actually perform any real economic activity in their country of establishment, although claiming to do so.

The core problem for the EU was captured well in a study commissioned by the European Trade Union Confederation (ETUC), which states a letterbox company is: “a business that establishes its domicile in a given Member State while conducting its (substantial) activities in other Member States for purposes of circumventing or evading applicable legal obligations (lower taxes, wages, labour standards and social security contributions)”. A unified and horizontal definition of a genuine company would help to distinguish between companies that are artificial arrangements (like letterbox companies) and companies with real activities. However such a definition is missing in the EU regulatory framework. A comparable definition across member states is also lacking, as is a definition in identical terms in the different policy areas at the national and EU levels.

Bypassing EU member state social provisions

By the late 1980s the first indications of the practice of bypassing rules through the use of foreign labour-only subcontractors had emerged, leading to questions about the possible relationship between cross-border labour recruitment and artificial company arrangements in the EU. The free provision of services by foreign entities resulted in their exemption from host country social security legislation, questionable practices in the field of income and corporate tax, and the watering down of national labour standards, mandatory pay and working conditions. The absence of genuine activities in the country of origin was combined with repeated cross-border work on an almost permanent basis. Letterbox companies were (and still are) opened for the purpose of recruiting workers for work abroad.

The regulatory framework related to this phenomenon is stretched over various areas, with incoherent, contradictory and even conflicting rules contained in company, labour and contract laws, internal market regulations, tax rulings and social security legislation. The patchwork of regulations and the fragmentation of the competence to control and enforce these regulations among different national authorities have made it difficult to monitor and combat abusive practices. The lack of cooperation between separate policy areas hinders effective action for inspection and enforcement. Moreover, legal complexity and loopholes hamper the application of the law, opening the door for ‘crooks’. Firms can easily, and at a low cost, be established in foreign constituencies, disappear across the border, go bankrupt and start all over again. It is, therefore, imperative to strengthen the legal framework and repair inconsistencies in a horizontal and coherent way. This asks for an impact assessment across a large part of the internal market regulatory framework, not only to protect workers, but also in the interest of genuine economic actors and customers.

Labour migration database

This expert opinion is based on an INT-AR research paper on a project investigating international labour migration. The database that has resulted from the project activities aims to provide an observatory of labour migration and its effects on the labour market. The database is regularly updated with new evidence from multidisciplinary research. For the full text please see here.