Commerzbank, Germany’s second-largest bank and partially government-owned, played an active role in helping foreign investors exploit a tax loophole that artificially lowered German tax payments by around €1 billion, or $1.1 billion, a year, research by Handelsblatt and a group of global media publications shows.
The trick allowed investors to lower their capital-gains tax payments and often claim maximum tax refunds from the German government by combining an investment technique called “dividend stripping’’ with the help of domestic banks such as Commerzbank.
Experts say the practice allowed foreign investors to avoid paying at least €1 billion in taxes each year in Germany for more than a decade. It is unclear what part of that sum was enabled with the help of Commerzbank. Data obtained from an unnamed source suggest it played a leading role.
The data was first obtained by New York-based ProPublica, an investigative journalism non-profit. Handelsblatt, the German television broadcaster ARD and the Washington Post newspaper sifted through extensive data to discover how the business worked, who were the participants and how much they saved on German capital gains taxes.
Dividend stripping is a once-legal technique used in the United States and elsewhere that enables investors to exploit the cyclical variations in a stock’s share price before and after a company pays out millions of euros in dividends. In Germany, the technique also exploited a German tax loophole to let foreign investors underpay or claim unjustified exemptions from German capital-gains taxes.
With the help of banks such as Commerzbank, foreign investors were able to claim tax rebates that are actually reserved for domestic investors. They did it by loaning their shares in blue-chip DAX companies to the banks for a short period around the time a dividend is paid out. The bank could then claim higher rebates than foreign investors are otherwise entitled to.
After the costs of dividend stripping came to light, Germany formally proposed legislation to outlaw the practice at the start of this year. The government may now attempt to pursue international investors or the domestic banks cooperating to reclaim some of the money it paid out through unintended refunds.
The loophole used by foreign investors is just one of many scandals surrounding dividend stripping that has gripped Germany in the past few years. Many investors, also with the help of more than one hundred global banks, for the past decade would buy millions of shares for a short period of time, using so-called short-selling techniques, in order to claim multiple rebates on capital-gains taxes. That loophole was finally closed in 2012.
The new data obtained by ProPublica, details how German banks and investment funds cooperated with foreign investors over much of the last decade to exploit a legal tax loophole to the detriment of German taxpayers.
The business had names such as “Yield Enhancement” or “Cum Cum Trade,” which refers to the Latin word “with”, meaning “including’’ as in the dividend.
Commerzbank declined to comment specifically on the allegations but told Handelsblatt: “We ensure through extensive internal systems and controls that all trading activities are in compliance with existing laws.”
The foreign investors included sovereign wealth funds from Dubai, Qatar and Singapore, and U.S. pension funds and asset managers such as BlackRock and Vanguard.
Under German law, only German shareholders are entitled to a full tax reimbursement for capital-gains taxes paid on dividends. Foreign shareholders get only a partial reimbursement.
To get around that restriction and claim full exemptions, some foreign investors, with the help of domestic banks such as Commerzbank, would lend shares to German banks and investment funds. The foreign investors included sovereign wealth funds from Dubai, Qatar and Singapore, and U.S. pension funds and asset managers such as BlackRock and Vanguard.
The German banks and investment funds would typically hold onto the loaned shares for two or three weeks, receive the dividends and claim full tax reimbursements on the taxes paid, which would ultimately be passed on to their foreign investor clients.
The arrangements were structured so that none of the parties – neither the foreign investors nor Commerzbank – had to take on significant financial risk. The foreign investors are willing to pay several millions of euros to their German counterparts in order to exploit the loophole.
U.S. asset managers Vanguard and BlackRock, for instance, were entitled to only about half the tax reimbursement they eventually obtained in Germany through the practice, the data showed. Other investors used different profit-sharing models.
Vanguard in a statement said only that it was engaging in a widely-used practice. BlackRock would not comment to Handelsblatt.
Frequent users of the loophole also include some of the biggest banks in the world, including Goldman Sachs, Morgan Stanley, Swedish bank SEB, Switzerland’s UBS and Barclays. Asked to respond, many declined comment, while SEB in a statement said only that it had followed the law.
Commerzbank, which was bailed out with €18.2 billion in government aid during the global financial crisis, was one of the biggest marketers of the loophole to foreign investors, the research showed. The Frankfurt-based bank, which is still partially owned by the German government, did much more business helping foreign investors exploit the loophole than much bigger banks.
The bank has offered the service to foreign investors at least 250 times between 2013 and 2015, research showed.
One example: On January 26, 2015, Commerzbank took over 47.7 million shares of the German conglomerate Siemens on behalf of foreign partners. The shares were worth more than €4 billion and briefly gave Commerzbank control of 5.41 percent of the company. Nine days later, after Siemens held an annual meeting and paid out dividends, Commerzbank sold the shares again. That one trick alone may have cost the German government €23.5 million.
The German government recently introduced legislation aiming to forbid such dividend stripping starting this year, but the government is also trying to reclaim money paid out in previous years.
Separately, more than one hundred banks still face potential investigations over other questionable or illegal forms of dividend stripping that they engaged in on behalf of investors – domestic and foreign – and that cost the German taxpayer as much as €12 billion.
Sönke Iwersen leads Handelsblatt team of investigative reporters. Volker Votsmeier is an editor with Handelsblatt’s investigative reporting team. Yasmin Osman is a financial editor with Handelsblatt’s banking team in Frankfurt. To contact the authors: email@example.com; firstname.lastname@example.org; email@example.com