The CumEx-Files Scandal: Tax Optimization Gone Wrong

The CumEx-Files scandal involved a massive tax evasion scheme that spanned over a decade, with billions of euros in unpaid taxes.

In 2010, a whistleblower alerted the authorities to the scheme, which involved a complex network of banks, law firms, and other financial institutions.

The scheme was centered around a loophole in European tax law that allowed for the "cum-ex" method of dividend stripping, where shares were bought and sold in a matter of seconds to claim tax refunds.

This loophole was exploited by a group of investors, who used it to claim over €55 billion in tax refunds.

The CumEx-Files scandal is a stark reminder that even the most complex financial schemes can be unraveled with the right information and cooperation.

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The Cum-Ex Scheme was built on a so-called “cum-ex” trade—a practice that was outlawed in 2012. This trade centers on an aggressive form of “dividend arbitrage” that gained notoriety in recent years in European countries.

A “cum-ex” trade was based upon a network of participants who would lend shares in a manner that created the appearance that there were two owners of the shares at the same time. This resulted in the issuance of a confirmation that tax on dividend payments had been paid, when in fact it had not.

Multiple parties would then seek a “refund” of the dividend withheld tax. In Germany, for example, until a 2012 change in the tax law, a dividend tax of 25% of the gross dividend was collected by the corporation that issued shares. The certificate for tax reimbursement, however, was issued by the shareholder’s bank.

Depository institutions often issued reimbursement certificates incorrectly, which allowed multiple investors to claim refunds of such taxes, even though only one party had actually paid the dividend tax.

Here is a simplified example of how the alleged scheme works:

The schemes are comprised of two mechanisms: one where traders try to collect tax reimbursements for non-existing tax payments and another where they are reimbursed twice for the same taxes. German traders would lend to each other shares of major corporations to make it seem to tax authorities that there were two owners of the shares.

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Then the bank that facilitated the transfer of the share would fabricate a ‘confirmation’ to the receiver that taxes have been paid on dividends -- profit from the shares paid to shareholders. The receiver would use this confirmation to claim tax returns for taxes that had never been paid.

A variant of the scheme, dubbed “cum-cum,” occurs when a foreign entity loans or transfers shares to a German bank, which receives a tax refund not available in the foreign entity’s country.

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The discovery of the CumEx-Files began with a whistleblower. August Schäfer, the German State Commissioner, first warned of the practice in 1992 after hearing testimony from five whistleblowers.

The warning fell on deaf ears, and the practice continued to thrive. An administrative assistant in the German Federal Central Tax Office eventually stumbled upon the issue.

The assistant noticed abnormally large tax rebate claims from a US pension fund. This was the break that led to a deeper investigation into the CumEx-Files.

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The CumEx Files Scandal exposed a massive tax evasion scheme in Europe, where traders and banks collaborated to cheat taxpayers out of €55 billion.

The schemes involved two mechanisms: one where traders tried to collect tax reimbursements for non-existing tax payments, and another where they were reimbursed twice for the same taxes.

A variant of the scheme, dubbed "cum-cum", occurs when a foreign entity loans or transfers shares to a German bank, which receives a tax refund not available in the foreign entity's country.

Hanno Berger, a German tax lawyer, invented the "CumEx" practices, which involved passing securities from one person to another very quickly, allowing multiple individuals to claim tax credits or refunds on dividends or dividend withholding tax.

These practices were brought to light by the investigative work of a group of international media and raised a scandal in several European countries.

The German authorities stopped cum-ex trading in 2012, but a second wave of tax swindlers have been using the scheme to be reimbursed while never having paid taxes.

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Sanjay Shah, a businessman, created cum-ex schemes outside of Germany and owns $56 million worth of property in Dubai, and is currently under investigation by German and Danish authorities for his role in various tax frauds.

Hanno Berger argued that it is legal to be reimbursed for taxes that were never paid, but his clients included Adidas, Karstadt, and the family that owns BMW.

Recent attempts have been made by legislation in certain EU jurisdictions to clarify the issue of beneficial ownership through statutory provision.

In 2017, the Financial Conduct Authority reviewed several firms involved in CumEx-style trading and found that some may not have properly assessed the risk of contrived or fraudulent trading for the purpose of making illegitimate WHT reclaims.

The European Securities and Markets Authority published a consultation in October 2019, considering potential changes to the MAR regime to tackle perceived gaps in the regulatory framework concerning WHT reclaim schemes.

Belgian legislation introduced new requirements to limit WHT reclaims, including a sixty-day holding requirement on any shares, which became effective on January 22, 2019.

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New rules have been put in place to tackle tax loopholes. Recent Belgian legislation, effective January 22, 2019, has made new requirements to limit WHT reclaims and imposes a sixty-day holding requirement on shares.

The Law of January 11th, 2019 on Combatting Tax Fraud and Tax Avoidance Regarding Withholding Tax has become a significant development in this area.

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FCA Requirements are in place to ensure firms involved in dividend arbitrage conduct their business with integrity and comply with regulatory requirements.

Firms must conduct their business with integrity, due skill, care, and diligence. This means being transparent and honest in all dealings.

They must also organise and control their affairs responsibly and effectively, which includes having adequate risk management systems in place.

Firms must maintain adequate policies and procedures to ensure regulatory compliance and to counter the risk of the firm's involvement in financial crime.

This includes regularly assessing the adequacy of counter money laundering systems and controls.

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FCA principle 11 requires firms to deal with their regulators in an open and cooperative way, and to disclose to the appropriate regulator anything relating to the firm of which that regulator would reasonably expect notice.

Firms must monitor new and existing clients and transactions and self-report anything that would reasonably be expected to be of interest to the FCA.

Here are the key FCA Requirements for firms involved in dividend arbitrage:

Firms must report anything that could constitute market abuse to the FCA without delay, as required under Article 16 of the EU Market Abuse Regulation.

Conducting thorough due diligence is crucial for firms potentially exposed to or involved in dividend arbitrage. This involves reviewing clients and transactions to identify any concerns.

The FCA rules, taken together with MAR, clearly indicate that firms should conduct extended due diligence on relevant clients and transactions. This diligence should be properly documented and considered for reporting to the FCA if any concerns arise.

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Any clients or transactions that raise concerns should be properly documented and considered for reporting to the FCA. This will help ensure that firms are taking proactive steps to address potential issues.

Pro-active co-operation with the authorities may also become relevant if the FCA were to make any referral to the Serious Fraud Office (SFO) to conduct any investigation into CumEx. This is especially true if a guilty finding is made in the German trial.

Corporate co-operation plays heavily into the SFO's charging decisions, making it essential for firms to consider their level of co-operation. The history of the Libor investigations and prosecutions suggests that outcomes for individuals at UK firms may be somewhat haphazard.

UK firms should consider the provisions of Part 3 of the Criminal Finances Act 2017, particularly section 46, which deals with failure to prevent facilitation of foreign tax evasion offences. This will help firms ensure they are taking all reasonable measures to prevent such facilitation.

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The CumEx trading model has been justified by those involved in various ways. They claim it was standard market custom and practice, not illegal, and that participants were not dishonest.

Investors like German businessman Carsten Maschmeyer blame the banks for not disclosing the source of their investment return.

Some argue that CumEx merely exploited a loophole in the state's tax law, and that the responsibility for this lay with the state.

The German state's tacit acceptance of CumEx as a profitable line of business for banks may also be a justification. This is indicated by the fact that State Commissioner August Schäfer was made aware of CumEx by whistle-blowers in 1992, but was ignored.

BaFin's executive director Elisabeth Roegele even defended CumEx when she was Chief Legal Officer of Dekabank, and declined to comment on its legality in March.

Different parties to the CumEx trading model may have their own bases for suggesting a lack of wrongdoing. The custodians of shares, brokers, lenders, and shareholders may all claim they bear no responsibility for the tax affairs of others.

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