The CumEx scandal has been the focus of international public attention ever since the publication of the so-called CumEx files. This was preceded by a global investigative research by journalists from various states. The accusation: The systematic, long-standing exploitation of an alleged tax loophole in German law to gain tax refunds that exceed the amount of tax actually paid many times over.
In Germany this issue has been known for a long time. Eventually the CumEx-scandal has experienced also a broad legal review. Court decisions, however, have been quite rare - this is changing: On 18 March 2020 the Bonn Regional Court delivered a fundamental judgement. According to the court CumEx-transactions justify the accusation of tax evasion. The Bonn Regional Court does not see any tax loophole, but on the contrary a deliberate tax offence.
The decision is wide-reaching, way beyond criminal law. CumEx-transactions have an enormous total exposure. For Germany alone, the damage potential is estimated at not less than EUR 55.2 billion. The last word is not spoken yet. In any case there is no doubt: the CumEx-scandal definitely will make further noise.
CumEx-transactions essentially aim to have capital gains tax paid only once and reimbursed several times through stock trading. The efforts are based on an argument according to which one and the same stocks can have several owners. This is allegedly the case, if an intermediary sells stocks to a buyer by way of a so-called short sale right before the dividend payment (cum dividend), but receives the stocks from the previous shareholder only after the dividend payment. The intermediary then transfers the stocks to the buyer (ex dividend) together with a compensation payment in the amount of the net dividend. Allegedly through the short sale, the buyer becomes a so-called beneficial owner of the stocks, even though these have not yet been delivered to him. Therefore, both the previous shareholder (actual owner) and the buyer (beneficial owner) shall be able to claim a refund of the capital gains tax which was paid only once on the dividend.
The tax authorities have not questioned this legal interpretation for a long time. This may be caused by the fact that CumEx-transactions have often not even been recognized as such due to the used stock trading structures, the high frequency trading and the tax certificates issued by the depository banks of the buyers.
It is unclear when exactly CumEx-transactions came up for the first time. The German financial jurisdiction indicates that CumEx-transactions took place already in 1990. The German legislator took various efforts - started from 2007 - in order to close the alleged tax loophole. The closure of the tax loophole is considered to be completed since the tax law reform of 2012.
Legal Review In Germany
The legal review of CumEx-transactions is progressing. First instance courts have not yet followed the argument of a legitimate exploitation of a tax loophole. A Supreme Court decision is still pending.
From the criminal law perspective, the competent public prosecutors have been involved in the investigation and prosecution of possible offences for some time now. The accusation: tax evasion. Investigations are being conducted against a large number of parties involved, including employees of credit institutions, investors and well-known former tax advisors, who are said to have confirmed the permissibility of the CumEx-transactions by providing legal opinions.
In this context, the current judgement of the Bonn Regional Court is as fundamental as it is wide-reaching. For the first time a German court has ruled that at least certain CumEx-transactions justify the accusation of tax evasion, ie a deliberate criminal act. Two former brokers who were involved in CumEx transactions were convicted. The trial is considered a kind of "test". Now that the Bonn Regional Court has affirmed the accusation of tax evasion, further charges and convictions will follow. The Wiesbaden Regional Court has already admitted criminal charges against one of the most prominent advisors in connection with CumEx-transactions. Another tax expert from a well-known law firm was remanded in custody at the end of 2019.
Imprisonment and rigid fines as well as the forfeiture of profits from the CumEx-transactions are possible consequences. The Bonn Regional Court, for instance, has sentenced one of the brokers to repay EUR 14 million despite the case being rather small. In addition, a Hamburg-based private bank involved in the proceedings as a so-called "party due to confiscation" (Einziehungsbeteiligte) is sentenced to pay an amount of approximately EUR 176 million. The Bonn Regional Court pulled the private bank into the proceedings pursuant to the German Criminal Procedure Code. Thereupon, the Regional Court sentenced the private bank to reimburse the profits from the CumEx-transactions in question.
Further legal clarifications of the CumEx-transactions are taking place before the financial courts in connection with tax refund claims. Also in this respect the tax loophole argument has not yet found any supporters among the competent judges. In particular, the Cologne Financial Court rejected the asserted tax refund claims in a comprehensively substantiated judgement of 19 July 2019 on the grounds that the buyer did not become the beneficial owner of the stocks by the conclusion of the stock purchase contract and therefore could not be a creditor of the capital gains. According to the Cologne Finance Court multiple ownership of stocks is generally excluded. As no capital gains tax was withheld and paid on behalf of the buyer, there was no right for a tax refund as well.
Against that background, the legal proceedings on the CumEx-transactions will more and more become an issue of liability law. In particular proceedings against managers of companies concerned with CumEx-transactions are very likely. The companies for example could try to pass on the fines and tax repayment obligations. Equally relevant in this context is the liability for professional consulting failures. For example, the Dusseldorf Higher Regional Court has sentenced a lawyer to pay damages in the amount of EUR 13.5 million due to consulting failures in connection with an investment product based on CumEx-transactions. In another prominent case the insolvency administrator of a Canadian bank prepared a statement of claim for EUR 95 million against a major law firm, whereupon the matter was settled at EUR 50 million. In the meantime, the same insolvency administrator has filed a claim for damages of EUR 95 million to the Stuttgart Regional Court against a large auditing firm that used to be mandated by the Canadian bank. In addition to the law firms and auditors who have been the focus of press coverage, it is known that further advisors have supported the CumEx-transactions by delivering – allegedly – inaccurate / "goodwill" legal opinions, so that further claims are likely to expect. Last but not least, the liability of members of Executive- and Supervisory-Boards is also at issue. An increase of claims must be expected as the legal review process continues. The mentioned insolvency administrator of the Canadian bank, for example, has already filed a claim to the Frankfurt a.M. Regional Court for a high double-digit million amount against the former Chairman of the Bank's Executive Board and two further executives.
Effects On The Insurance Market
The judgement of the Bonn Regional Court that CumEx-transactions constitute a deliberate tax offence has a large impact on the insurance market. Among others, the field of Financial Lines is strongly affected, especially PI, E&O and D&O. Equally relevant in this context are (criminal) legal costs policies, especially since CumEx-transactions involve complex and protracted proceedings. Bonn's determination of deliberate behaviour leads to the possible exclusion of deliberate failures. In this respect, however, probably a distinction must be made between different parties involved. Besides, for first instance there is an insurers' obligation to finance defence costs in the complex and protracted proceedings.
The legal review of the CumEx-scandal is far from complete and liability issues are still in their beginning. Also against the background of limitation periods there will be an increase of CumEx-proceedings in all areas. Another thrilling issue is whether the criminal law decision of the Bonn Regional Court will be upheld by the Federal Supreme Court. The Hamburg-based private bank has filed an appeal. In any case, all parties involved as well as the insurers should keep on closely monitoring the progress of the CumEx-scandal legal review. This not only concerns for first instance the developments in Germany, but the likely impact on other European countries as well. The investors, banks and advisors involved are also based in the international financial centres, so that insurers of law firms in New York or banks in Paris, for example, definitely should have the issue on their agenda. Finally, other, related transactions are increasingly in focus, such as so-called CumCum-transactions. These were used to gain tax advantages for foreign investors that at least were not really intended by the German tax law, eg by "lending" of stocks in favour of a domestic investor around the dividend date and the subsequent sharing of the tax refund obtained by the domestic investor via the lending fee. Therefore, one thing is for sure: More to come!
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.