Legal dodge

Loophole Ruling Proves Taxing

Foto: Jens Büttner/dpa
But will the taxman get any back?
  • Why it matters

    Why it matters

    Germany’s tax office had hoped to recoup some of the billions it lost in tax through the dividend stripping loophole. A new court ruling suggests this is unlikely.

  • Facts

    Facts

    • The cost to Germany’s tax coffers has been estimated at €12 billion over 10 years.
    • The Federal Fiscal Court blamed the government for failing to close the loophole, rather than individuals for taking advantage.
    • Prosecutors say they will go ahead with cases against potential tax dodgers regardless.
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    Audio

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It’s a complex ruling, but one that will have many tax dodgers scrambling for their accountants’ phone numbers.

Last week, a German court dedicated to financial issues ruled on the legality of exploiting tax loopholes through a practice known as dividend stripping. The judgement begged many questions over clarity, but it is likely to have major consequences for Germany’s tax authorities, and has left industry insiders poring over its details.

Dividend stripping involves buying shares – sometimes billions of euros worth – just before a company pays out dividends to shareholders, and then selling them again shortly after. By carrying out these transactions with borrowed money – short-selling – the customers are able to sell the shares at a loss without losing any actual money. And yet the “loss” qualifies them for multiple tax exemptions under German law, ultimately lowering the taxes they have to pay on their overall capital gains revenues.

The complexity of the loophole means that many groups will be affected by the ruling: tax attorneys who helped create the deals; banks that offered them; customers who raked in millions, but who have since found themselves investigated not just by tax authorities but by state prosecutors for tax fraud; and finally the taxman, who is estimated to have lost up to €12 billion in revenue and is now trying to recoup some of it.

The complexity of the loophole means that many groups will be affected by the ruling.

What is clear is that businesses and individuals in Germany engaged in dividend swapping with the express purpose of exploiting a loophole in German tax law. Less clear is just who should be held responsible.

“What is scandalous… is how many actors on both the supply and demand side got rich from this model, reaching into the tax kitty without taking any risk, and without any measures being taken to counter the practice,” said Gerhard Schick, a spokesman on fiscal affairs for the Green Party, which has called for an investigation into the government’s handling of the case.

The victim was always the tax office. In the ten years before the loophole was closed in 2012, big earners were able to get multiple tax refunds from the same pot that average taxpayers pay into. Germany’s Federal Fiscal Court raised concerns about the loophole in 1999, and yet it took 13 years for politicians to end the practice.

But was the loophole illegal? The Federal Fiscal Court’s new ruling seems to highlight the government’s failure in the matter, rather than blame the customer.

“Contrary to the arguments put forward by the Finance Ministry in the hearing,” the court ruling states, legislators had “avowedly made the assumption” that company shares bought through short selling can still be counted as economic property for tax purposes. In other words, German law allowed you to own shares that you didn’t buy with your own money.

“What is scandalous… is how many actors on both the supply and demand side got rich from this model.”

Gerhard Schick, Green Party spokesman

So did the Federal Ministry of Finance give wrong information to the court?

“The representatives have made no false statements,” said finance ministry spokesman Stefan Kirsch. When it comes to the legislative passages in question, it’s a matter of your point of view, he added. “The BMF remains of the opinion that, while some of the passages that gave the grounds for this decision may have been ambiguously formulated, it is out of the question that legislators intended to regulate the transfer of economic ownership in the case of short selling in favor of a (short selling) buyer,” he said.

The finance ministry’s statements appear downright ridiculous to legal experts. Surely you can’t expect a citizen and tax lawyer to simply ignore something that is explicitly clear in legislation, said one Berlin lawyer involved in investigations against dividend strippers. What counts is what is written down and not what legislators intended, he said.

The government has been given several warnings over the years about how it had legalized the practice of dipping into tax coffers through these dividend deals. “The government authorities have taken ten years to put an end to these going-ons,” said Mr. Schick.

The state’s guilt is one thing. But what about the guilt of those who took advantage of the state’s failures? Some lawyers consider the statements by the Federal Fiscal Court to be a milestone. “The ruling has considerable explosive power,” said a tax expert at a major law firm, who declined to be named. “The court’s potshot is obvious. It makes clear it has no interest in repairing bad tax laws.”

Whether individuals are charged in the future will likely come down to how blatant they were.

This suggests, in the eyes of another lawyer involved in the case, that such deals “have basically been decriminalized. After this ruling, the bar for public prosecutions will be considerably higher before they are allowed to proceed with an investigation.”

Law enforcement agencies disagree. Thomas Steinkraus-Koch, spokesperson for Munich prosecutor’s office, said the ruling doesn’t bar his office from building a criminal case against people who purposely sold stocks after dividend payments, and followed this up by filing the necessary tax payments with authorities.

Whether individuals are charged in the future will likely come down to how blatant they were. In the court case that led to last week’s ruling, the tax dodger was found to be in the wrong. But experts agree that this was because the dealer had been slapdash. The company, located in Northern Germany, had the dividend-stripping ploy tailor-made by a bank and didn’t develop any actual trading activities of its own. In such a case, the court found, the tax refunds he pocketed were not permissible.

By that logic he has nothing to fear, said tax expert Hanno Berger, who has also been involved in dividend stripping. He did his trading personally. “The business just has to be structured accordingly. I see my position confirmed by this ruling,” he said.

 

Sönke Iwersen leads the investigative team at Handelsblatt, Laura de la Motte is a reporter covering banks and Christopher Cemak is an editor at Handelsblatt Global Edition focusing on finance. To contact the authors: Iwersen@handelsblatt.com DelaMotte@handelsblatt.com Cermak@handelsblatt.com

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