Organized crime in pinstripes? – The tax robbery with cum-ex and cum-cum deals

by Julian Klinkhammer and Markus Pohlmann

Cum-cum and cum-ex transactions (Cum/Ex) enabled „the biggest tax theft in the history of Europe“, concluded Dr. Christoph Spengel, Professor of Business Taxation at the University of Mannheim, who had prepared a report for the 4th Enquiry Committee of the German Bundestag on Cum/Ex. A German insider, who worked as a lawyer for a long time on specialized Cum/Ex transactions, spilled the beans in front of the running camera. He reports exclusively from the „engine room“ of this „devil’s machine,“ as he calls it. After 14 months of interrogation by the Cologne public prosecutor, he was able to convince himself that he was part of a system of „organized crime in pinstripes“ between 2006 and 2011. What has actually happened and what is behind the scandal?

Source: Pixabay

Exploitation of „regulatory gaps“ through tax-driven stock transactions

The story behind the scandal is quickly told, because the business model called Cum/Ex is relatively simple. Cum-Ex is a form of „dividend stripping“ that has long been considered one of many tax planning models, and in principle aimed at the return of capital gains taxes. In the case of short sales of shares traded shortly before the dividend cut-off date with (cum) and on redemption without (ex) dividend entitlement, the same shares could be temporarily attributed to different owners and therefore multiple returns of capital gains tax could be obtained. In the first-instance decisions to the disadvantage of DekaBank (2016) and Commerzbank (2017), the Hessian Financial Court ruled that the German legislature had closed this regulatory gap with the 2007 Annual Tax Law at the latest.

A financial judge, who was then on secondment to the Federal Ministry of Finance, apparently copied pre-formulated passages of the banking association in the law. Its entry into force made it possible, from many banks‘ point of view, to run the lucrative trades from 2008 onwards legally through custodial banks abroad. The „regulatory gap“ of cum-ex, which was thus kept open, was only closed in 2012 and until then apparently massively exploited, because the income of the trades depends heavily on the volume of transactions. Subsequently, the participating banks put more emphasis on cum-cum deals where the capital gains tax return paid to the resident taxpayer was shared with a foreign shareholder. This gap was statutorily closed in 2016.

Source: Pixabay

For the enquiry committee set up by the Bundestag, it has already become clear in 2016 „what the actors wanted to achieve with the transactions.“ The necessary pieces of the puzzle were also fully available to the Cologne prosecutor’s office in 2017, as they began with the interrogation of the insider. In retrospect, this insider compared the state to a farmer who left the door to the henhouse wide open and, despite hints from the foxes, allowed them to snatch chickens unhindered. Why has the state allowed for such a long time that a „pack“ of bankers, lawyers, advisors, brokers and investors systematically eviscerate the treasury „like a Christmas goose“ (Spengel)?

No one knows exactly how great the damage is to the affected states. But there are well-founded estimates. The Federal Ministry of Finance knows of 418 case complexes with a volume of approximately 5.7 billion euros, but expects much less damage to the German tax authorities. Higher estimates are a product of science. Across Europe, according to the expert Spengel, it added up to more than 55 billion euros, which was eventually withdrawn from the state budgets. Importantly, these are conservative estimates. If the calculation bases are correct, the actual damage may be even greater.

In which circumstances the Cum/Ex-Deals were criminal transactions, is currently controversial among lawyers and will still have to be clarified by the highest court.

Neoliberal ideas and safe returns in times of low interest rates

At the level of the actors, the explanation of the insider remains thin and focused on interests in profits. In a sociological explanation, one must also start with the neoliberal thinking patterns and the integration mechanisms of the inner circle of the cum-ex deals („state as enemy”). Brooke Harrington has observed these empirically in regard to wealth managers in tax havens. Their adaptation has been excellently presented by the German insider on the basis of his own professional socialization. He compares his career with the entry into a spaceship, whose flight brought him quickly into ever higher income spheres. Whenever a professional sense of injustice sprouted in him, one thing had to be clear to him: The price of moral scruples also meant the career exit from this spaceship, which took everyone in this conspiratorial circle into other orbits.

Source: Pixabay

At the organizational level, the embedding of Cum/Ex deals in the strategic direction of banks remains underexposed. In addition to secret networks, unsound financial service providers and fraudulent personalities, even well-known law firms and renowned big banks operated in this particularly lucrative „cum-ex-market“ for returns from tax revenues – another variant of „organizational deviance.“ Take as an example a traditional private bank in Basel. This bank had already turned away from the lucrative management of dirty money in 2010 and therefore earlier than other Swiss institutions. As a result, their managers worked out a strategy in the „Project Summit Attempt“ to conquer the market segment of the so-called ultra high net worth individuals (UHNWI). For this purpose, they also offered German clients specialized in cum-ex-deals products of a fund company in Luxembourg. Customer discussions lasted about 15 minutes on average, the fund was allegedly praised as „insured by Allianz.“ In an internal document of the bank from 2011, from which the Swiss daily Tages-Anzeiger quotes, it is written unequivocally that the investor would reap benefits from this investment;

“which he would not otherwise be entitled to […]. This product is (…) by tax law and ‘for the sake of tax-reputation’ rated as not ok.”

Not the private insurance company, but the German state guaranteed the outstanding profits of more than 10 percent. Only the inadequate political regulation of these tax businesses has made this level of trickery possible. Of course, there is much speculation about the political background. In their statements, the finance ministers responsible at the time appealed to the Bundestag’s enquiry committee mainly on ignorance (Peer Steinbrück, SPD), the complexity of tax law and the federal structure of the tax state in Germany (Wolfgang Schäuble, CDU). Those who have been dealing with bureaucracy for a long time may find these explanations plausible. The opposition speaks pointedly of „organizational failure“ in the Federal Ministry of Finance. A representative of the tax investigation admitted before the enquiry committee that one has given self-disclosures of the banks – who even issued a tax certificate to the short sellers and, if necessary, to themselves as the custodian bank – too much faith. A survey of German Banks shows how fatal this widespread confidence in the reliability of the regulated institutions was: of these banks, eleven have owned up to a settlement with the Federal Financial Supervisory Authority (Bafin) on cum-ex-deals. Seven other banks denied any involvement, although the Bafin already had information to the contrary.

For a long time, the European dimension of the scandal remained severely underexposed; among them the differences in the course and extent of the „raids“, the large number of affected EU member states as well as political reasons for the passivity of the supervisory authorities. As in other instances of organizational deviance, it is not just one or two companies, but several law firms and banks in Europe operating in this deviant realm of the financial sector.

The evidence in fact speaks for a strong entanglement of economic and political interests in the wake of bank bailouts, which has set certain limits to – at least until 2016 – stricter banking regulation in Germany and abetted the offshoring of the Cum/Ex transactions to other European countries. The irony of the story is that the tax state is both a victim and a beneficiary from this trickery – mediated through better bank balance sheets of state-co-financed or controlled banks. It was not until the revelations of Panama Papers and Paradise Papers that the EU developed a new approach to early track tax loopholes; a supply-side reporting requirement for cross-border tax planning models. By the end of 2019, EU member states must implement this directive.

 

References

Website von Prof. Dr. Christoph Spengel zum Thema Cum-Cum/Cum-Ex, Uni Mannheim

– Zusammenfassung der Ergebnisse des Untersuchungsausschusses: „Deutscher Bundestag – Cum/Ex: Gewinn macht nur der Leerverkäufer“

– Deutscher Bundestag, PuK 2 – Parlamentsnachrichten (19.01.2016): „Dividendenstripping teilweise zulässig“

– Juristische Analyse der Rechtsprechung in Deutschland: Dr. Christoph Knauer und Sören Schomburg: „Wirtschaftskrimi Cum/Ex-Geschäfte: Wenn die Verfassung die Steuer überholt, in: Legal Tribune Online, 12.04.2017.

– Correctiv über die “CumEx Files”

– Deutschlandfunk: „Strafbare Cum-ex-Geschäfte – Es wird weiter gehandelt“

– Schletti, Bruno (2013), Das Doppelspiel der Bank Sarasin, in: Tagesanzeiger 07.11.2013.

– Urry, John (2014), Offshoring, Cambridge: Polity


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