In recent years, our German friends have taken a pretty dim view of tax avoidance, especially as practiced by its southern neighbor, poking around bank offices when it can, breaking that southern neighbor’s laws when it can’t, and generally keeping prosecutors plenty busy with the results.
Even this Teutonic thoroughness, however, has allowed some things to fall between the gaps, as those muckrakers over at ProPublica have found.
It seems that banks and fund managers have been stiffing the Germans of about $1 billion in taxes every year through dividend-arbitrage transactions, explained in the handy diagram below, and the accompanying graph showing that essentially no one borrows German securities except around record-date time such that securities-lending charts look suspiciously like EKGs for hearts that beats once a year. Then, overseas funds lend their shares in dividend-paying German companies to German entities, like, say, taxpayer-bailed out Commerzbank, or a German fund, which are exempt from Germany’s 15% dividend tax. The funds get their shares back, everybody splits the savings and everybody is happy, except of course the German taxman and politicians who don’t like being made to look stupid.
But - you say - that’s on them! They shouldn’t have carefully constructed a mile-wide loophole, especially given the fuss raised about the whole thing in the U.S. a few years back which led to the U.S. banning div-arb.
Except there is a little German law that says you can’t engage in a transaction whose only purpose is to avoid taxes. And, certainly, tax considerations don’t appear far from these transactors minds.
The purpose of the loan, he wrote, was to “avoid” a 15 percent withholding tax on shares of international companies by agreeing to a 50–50 split of the taxes saved.
“We do not necessarily know the motivation for borrowing, or who the end user is, but are aware that tax considerations are one of several drivers for pricing these transactions,” a spokesman for the fund said in an email….
Another bank prepared an explainer for clients that says, “We’re not going to pretend to be tax experts, but it goes something like this.” The explainer then details how investors can avoid taxes by lending shares over dividend dates….
In another case, Commerzbank emailed another party in one deal asking to renegotiate after learning that a portion of the dividend would be tax-exempt. That would reduce the tax benefit of the transaction.
Well, enjoy it while you can—or prepare to make haste for Canada or France...or Israel...or Singapore...or Japan or....of course, Switzerland—because the Germans are getting ready to make it doubly illegal.
"To make it clear: we consider the cum-cum deals illegitimate because their sole purpose is to avoid the legal taxation of dividends," a spokesman for Germany's finance ministry said….
German Chancellor Angela Merkel's cabinet in February drafted a law to close the loophole.