It is said that the history of tax avoidance is as long as the history of tax. One of the latest tax avoidance strategies, which has seemingly crossed the line to illegal tax evasion, is that of “Cum-Ex” share trading, sometimes referred to as “dividend stripping.” For the past few years, German authorities have led the investigation into the practice and many other European countries are now embarking upon enquiries of their own. It is estimated that tax losses to European treasuries resulting from “Cum-Ex” schemes run to more than EUR 50 billion (more than USD 60 billion).

The German lawyer purported to have formulated the practice has challenged his indictment by German authorities for aggravated tax evasion in the European Court of Human Rights. Most recently, the administrator for a now-defunct German subsidiary of a foreign bank has filed a suit against an international law firm, seeking damages for incorrectly opining as to the legality of the trades. That action has precipitated another probe by German authorities into whether the law firm in question may be guilty of aiding and abetting tax fraud. It seems likely that other professional advisers will be subject to similar scrutiny.

“Cum-Ex” Transactions, Multiple Tax Rebates, Dividend Fraud

Latin for “with-without,” the alleged scheme involved the acquisition of shares with (i.e., “cum”) a dividend, on or just before the dividend record date, and delivery of these shares after the dividend record date without (i.e., “ex”) dividend. To tax authorities, there would appear momentarily to be two owners of the shares, when in reality there was only one, making it possible to obtain two rebates of capital gains tax paid only once. In order to create the impression of dual ownership, it was necessary for the parties involved, banks included, to trade huge volumes of shares concurrently.

The German Federal Ministry of Finance in a parliamentary inquiry held in Berlin described the Cum-Ex scheme as “organized crime.” Germany has amended its laws in order to close the legal loophole that gave rise to the practice and bring it to an end; however, the resultant tax losses are still being determined and allegedly run to many billions.

Challenge in the European Court of Human Rights

The German lawyer believed to have discovered and audaciously exploited the loophole in German law is now being prosecuted in Wiesbaden, along with a number of co-conspirators, for aggravated tax evasion. They face up to 10 years in jail.

Prior to that indictment, authorities conducted a number of raids in order to gather evidence, including on the lawyer’s offices and private residences in Germany and Switzerland. The lawyer then challenged use of the documents seized during the raids by the public prosecutor. Germany’s top court ultimately found that the raids were legitimate, holding that the searches were compatible with the country’s constitution and confirming a lower court’s finding that there was “a suspicion of especially grave tax evasion.” The lawyer has now taken his case to Strasbourg, seeking a declaration from the European Court of Human Rights that the documents are inadmissible.

Insolvent Bank Sues International Law Firm for Incorrect Advice

Meanwhile, an international law firm has reportedly confirmed that it is being suedfor damages by the administrator for the now-defunct German subsidiary of a foreign bank. The EUR 95 million suit, filed in the Frankfurt District Court, alleges that the firm incorrectly advised the bank for years that the “Cum-Ex” deals were legal.

The bank was raided as part of the investigation into “Cum-Ex” deals and related money laundering and, shortly after, Germany’s Federal Financial Supervisory Authority (BaFin) blocked it from trading because of potential liabilities tied to the “Cum-Ex” trades. Ultimately, those liabilities saw the bank declared insolvent for over-indebtedness.

The Frankfurt Public Prosecutor’s Office is now reportedly investigating the law firm for alleged tax fraud related to “Cum-Ex” trades at the bank, and has already raided the firm’s Frankfurt office a number of times as part of the enquiry, most recently on November 14, 2018.

Additional Considerations

Reported additional tax revenues for Germany of EUR 140 million (USD ~170 million), from financial penalties and clawback of tax arrears arising out of Panama Papers disclosures, pale in comparison to the estimated “Cum-Ex” losses to the German Exchequer. Christoph Spengel, a tax expert from the University of Mannheim, calculated that German tax authorities had lost almost EUR 32 billion(USD ~36 billion) of revenue between 2001 and 2016 and described it as “the biggest robbery in European history.” The latest estimates are that the aggregate damage to state treasuries across Europe run to somewhere between EUR 55.2 billion (USD ~62 billion) and EUR 62.9 billion (USD ~70.5 billion).

Likely, there are more indictments to follow. For example, prosecutors in Cologne are reported to be investigating the role of dozens of banks, brokerages, accountants, and law firms in the development and deployment of the “Cum-Ex” tax evasion model. Prosecutors in other European countries will follow suit.