Several high-profile banks including Deutsche Bank, Commerzbank and Hypo Real Estate, as well as some German state federal banks such as HSH Nordbank, could face retroactive punishment over their alleged involvement in so-called “cum-ex” dividend transactions before they were outlawed in 2012.
Some banks have continued to use the method, and Germany is likely to respond by bringing in a newer, more rigorous concept of beneficial ownership.
One tax adviser faces criminal charges – with more likely to be charged in the coming months.
“Cum-ex dividend transactions are very important for German banks at the moment,” said Axel Schilder, partner at King & Spalding. “Deutsche is one, but there are several other banking institutes involved in such transactions.”
“Deutsche is part of investigations by the German tax authorities, and we can see it from our tower [TaunusTurm building, Frankfurt] here when the police cars stopped in Deutsche I think four times over the last one and a half years.”
When a dividend belongs to the seller, not the buyer, it can be given “ex-dividend” status if a person has been confirmed to have received a dividend payment from it, pre-sale. Buyers of securities are entitled to receive a “cum dividend” which has been declared, but not paid.
Essentially, cum-ex dividend transactions take advantage of German tax law by claiming a withholding tax refund from the authorities, more than once.
Through cum-ex trades, banks can gain a tax advantage of 25% withholding tax, plus a solidarity charge bringing a total saving of 26.83%. Some trades using the method have been as large as €350 million.
“These are big banks doing a lot of transactions for institutional investors, and they are in the focus of the tax authorities,” said Schilder.
Authorities have carried out multiple raids on banks to try to gather sufficient information to prove that there are agreements in place to carry out cum-ex trades in the future.
Candian Maple Bank, the German branch of which was searched by almost 300 investigators on September 23, is suspected to have evaded up to €450 million in taxes [link in German]. Other banks have already begun to prepare for fines totalling hundreds of millions of euros.
“What we saw is that the banks seem to have reflected some risks in their balance sheets,” said Schilder.
One bank under investigation is HypoVereinsbank which, in its half-yearly financial report, released on June 30, said: “The General Public Prosecutor has initiated proceedings against HVB for an administrative fine according to the German Administrative Offences Act,” for transactions carried out with a client between 2006 and 2008.
“There is a risk that HVB could be subject to penalties, fines and profit claw backs, and/or criminal exposure,” said the bank. “At this time it is not possible to assess the timing, extent, scope or impact of the decision.”
Scope of investigations and time-barring
The investigations into cum-ex trades could stretch back further than 10 years, although there is debate about whether or not this will be the case.
While the loophole was closed in 2012 and cases coming after that will most likely be treated as tax fraud, some criminal law experts think that retroactive inspections of cum-ex transactions could reach much further back because of “time-barring”.
Time barring is a system in the general German tax code which usually stretches back by four years from the end of a fiscal year (December 31), during which taxes, including personal income tax, corporate income tax, VAT and withholding tax, are assessed by a tax note.
This four-year period essentially becomes a five-year period, however, when filing tax returns, which are done for the previous year. However, when it comes to tax fraud and tax evasion, the four-year period is extended to a 10-year period, effectively 11 years for some tax returns.
“If we have a decision of the federal fiscal court and also by the authorities examining all these transactions from a criminal law perspective, [and it makes the] assessment that that is a tax fraud here, then it really will be a mess for all the banks and all the investors involved in these transactions,” said Schilder.
Some banks argue, however, that for transactions before 2012 the tax authorities were aware of the cum-ex method and sent out withholding tax certificates to parties involved, amounting to a tacit acceptance of the scheme before it was later banned.
Some decisions have also gone in favour of dividend-stripping transactions, leading some advisers to believe they are acceptable under German law, rather than explicit tax evasion.
“So this is the counter-argument, to say was this really a wilful tax evasion or was it only the use of opportunities that German tax law provided for,” said Schilder. “That will be the core point and the key argument, and of course the major impact we will see from that decision should it go one way or the other.”
The German press has reported that one tax adviser, Hanno Berger, is facing criminal procedures related to cum-ex trades.
Beneficial ownership
The ramifications of cum-ex trades are likely to be felt far beyond banking, because the government and tax authorities are likely to re-define the concept of beneficial ownership.
Beneficial ownership will also be addressed in the OECD’s report on base erosion and profit shifting (BEPS), due to be released next week.
“We had also these discussions of how can we deal with the term “beneficial owner”, who is the beneficial owner, what requirements need to be met,” said Schilder. “Australia introduced a 60-day period. So if you’ve got all the risk and all the chances transferred by a formal legal owner, you have to stay with that investment - in our case with the stocks - for at least 60 days.”
“That’s something the German legislator also is considering at the moment, to introduce such a fixed time period. If that holds true, all that short rates around the dividend payment dates will not make sense any more from a commercial perspective. That would be, really, a deal-stopper.”
The first hearing concerning cum-ex trades took place in May. A decision is expected in spring 2016.
Deutsche Bank is also facing a $190 million law suit in the US, relating to an alleged tax fraud, however this is unrelated to cum-ex trades.
