German lawmakers weigh proposal to curb tax avoidance through cross-border dividend arbitrage

by Ninja-Antonia Reggelin

The finance committee of the German Parliament (Bundestag) on Monday held an expert hearing on reform of the investment tax law which was dominated by discussion of proposed measures to combat tax avoidance in the German banking sector through dividend arbitrage.

The draft investment tax reform law, proposed to be effective in 2018, aims to completely overhaul the German tax regime for mutual funds and to amend the treatment of so-called special funds (funds that can have up to 100 investors, none of whom can be private individuals).

Under the proposal, mutual investment funds would not be treated as transparent entities for tax purposes. Income would be taxed instead at the level of the fund as well as at the level of the investor who, in turn, receives a tax exemption for part of the income. If further conditions are met, the fund is exempt from German trade tax (Gewerbesteuer). The reform is partly justified on a claimed need to restore EU law compatibility.

A main goal of the reform is to effectively reduce aggressive tax avoidance opportunities through cross-border dividend arbitrage. These transactions, known as “cum-cum-deals,” have received heightened scrutiny in Germany following a highly-publicized media investigation that concluded that the scheme costs the German treasury millions of Euros in lost tax revenue.

The transactions are based on avoiding German capital gains tax of 15 percent imposed on foreign investors that receive dividend distributions from German companies. The shares or securities are temporarily lent to a financial service provider resident in Germany just before the dividend record date, who in turn claims a capital gains tax reimbursement. Just after the dividend record date, the shares are returned to the foreign investor. Exchange risks are hedged in the meantime and both parties share the avoided tax.

Legally these deals remain ambiguous. The finance ministry considers the activities illegitimate because the sole purpose is to avoid taxation of dividends. Furthermore, by merely lending the share, the beneficial ownership is not transferred. The deal could thus be characterized as a wholly artificial arrangement under Germany’s general anti avoidance clause (§42 AO).

Other arrangements, for example involving a sale and repurchase of shares, are not so easy to determine, though. Consequently, there are doubts about whether the German tax authorities can recover all tax claims.

To prevent any dividend arbitrage in the future, the draft investment law would introduce a minimum holding period. Tax would not be credited if the taxpayer is not owner of the share or security for 45 days within a 91 days’ time frame around the dividend date. Joachim Moritz of Allen & Overy LLP, Bela Jansen of WTS Group, and a representative of the German Fund Association were among hearing experts that argued that this provision could be too far reaching as it also encompasses perfectly legitimate and necessary hedging transactions.

The initial investment tax discussion draft also envisaged an extension of capital gains taxation to income realized on the sale of portfolio corporate shareholdings of less than 10 percent. Currently, only dividends are taxable for a corporate shareholder with such portfolio shareholdings, while capital gains are effectively 95 percent tax exempt.

Although the provision was omitted during previous stages of the legislative process it was nonetheless discussed during the hearing, with one expert, Professor Joachim Larras, supporting the extended taxation to ensure compatibility with dividend taxation of small shares. Experts representing the Institute of Public Auditors in Germany (IDW) and the German Industry Association (BDI) were among those disagreeing, arguing that the tax free status was essential for investors in startups or for pension funds.

In the meantime, the government has rejected proposals of the Federal Assembly to reintroduce the taxation provision in the draft law based on the notion that this would imply an additional tax burden on young innovative companies. The official statement does however mention that a possible solution for taxation has “not yet” been, found implying that they might still be considering extending the tax. See:

Overall the hearing experts concluded that the new provisions might reduce certain tax avoidance schemes, but suggested it would also open new opportunities as the law contains many new and complicated provisions.

The German Federal Assembly has already debated the law and submitted its comments which were partly addressed by the government in its opinion of April 26. The Parliament still needs to pass the law. It is likely that the legislative process could be completed the summer break.

Ninja-Antonia Reggelin

Ninja-Antonia Reggelin

Ninja-Antonia Reggelin is based in Berlin, where she is head of tax policy at a business association.

She previously worked at the OECD, contributing to the project that led to the publication of the BEPS Action Plan. Prior to that, she was with PwC Germany, where she focused on international tax structuring.

Ninja holds a Master’s degree (LL.M.) in International Trade Law from Bond University Australia and a Master’s degree (M.A.) in International Relations from the University of Kent Brussels School of International Studies.

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