Luxembourg flag must move away from its reliance on hosting internal financing functions for multinational businesses if it wants to guard against the impact of a G20-led crackdown on international tax avoidance, the Organisation for Economic Co-operation and Development (OECD) has warned.

The grand duchy, which has a population of 550,000 and among the highest average income of any developed economy, received the warning from Angel Gurría, secretary-general of the OECD.

“Luxembourg is one of the most prosperous countries in the OECD,” Gurría said, but warned that the country faced “important challenges”, including its heavy economic dependence on the financial sector.

Gurría was speaking as the OECD published its 115-page economic survey of Luxembourg. The survey found: “There is a risk that in the near future Luxembourg could face lower revenues from multinational enterprises as a consequence of the ongoing evolution of international tax regulations that necessarily trigger changes of tax rulings.”

Asked last year if the G20-led crackdown on tax avoidance represented a danger to Luxembourg’s economy, one senior figure closely involved in the reform programme said: “I don’t care. It is like saying: ‘If you fight drugs there will be no jobs in certain parts of Mexico.’”

Up until the 1970s Luxembourg had a strong economy built around the steel industry, but it has since been transformed into a hub for the internal financial activities of multinational corporations. In many cases such internal lending has been designed more to minimise tax bills than to meet internal borrowing needs with a multinational group.

This has led to criticism of the tiny EU state and has cast a shadow over Jean-Claude Juncker, the European commission president, who played an instrumental role in creating and nurturing Luxembourg’s financial industry during his 18 years as prime minister.

The economic survey, published on Friday, recommends that Luxembourg continues to cooperate with G20-led efforts on tax reform, which are being thrashed out through the OECD, despite the challenges such reforms may pose for the local economy.

Last week Alan Yarrow, who represents the UK’s financial sector in his role as Lord Mayor of London, met Luxembourg finance minister Pierre Gramegna. Yarrow is reported as praising the country “very interesting and necessary part of the European offering,” while also calling its financial sector “nimble”, “bright” and quick to adapt.

Last year the Guardian and more than 20 other media outlets around the world published separate investigations into tax avoidance based on hundreds of leaked tax rulings secured from the Luxembourg tax authorities by some of the world’s largest multinationals.

