Handelsblatt Exclusive

Turning a Blind Eye

  • Why it matters

    Why it matters

    The German government is allowing banks to continue with questionable trades that shield foreign investors from paying capital gains taxes. It’s a scandal gaining national attention, and one that Germany’s center-left SPD party could make into an election issue next year.

  • Facts


    • In a decree dated November 18, tax authorities in the German state of Hesse, where the country’s financial capital Frankfurt is based, ordered auditors to end their investigations into banks involved in a form of dividend stripping.
    • The decree from Hesse followed the publication of a letter from the federal ministry of finance, which acknowledges that such deals are in principle illegal but allowed key exceptions.
    • The move has sparked outrage from ministers at a regional and national level, leading to calls for the finance ministry’s circular to be amended.
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“Supermond” über Frankfurt am Main
Frankfurt's banks may be getting a pass, but many other states aren't happy about it. Source: DPA

Thomas Schäfer made his feelings pretty clear when Commerzbank, Germany’s second largest bank, hit the headlines back in May for all the wrong reasons.

“In my opinion, these deals are purely a tax trick at the expense of society,” the finance minister of the German state of Hesse said.

He was talking about Commerzbank’s involvement in a form of dividend stripping that allowed foreign investors to escape paying capital gains taxes – a practice that reportedly costs Berlin hundreds of millions of euros a year.

And yet, today, it seems Commerzbank can relax. Fiscal authorities in Mr. Schäfer’s state have effectively granted the bank, and many other institutions that took part in such deals, a license to continue engaging in these controversial activities.

The German government doesn't seem to mind.

According to information received by Handelsblatt, the tax offices of Hesse have been instructed to end their investigation into the banks involved. The most controversial part? There are indications that the German government and individual states may have turned their backs on the practice in order to protect regional public-sector banks from possible fines and back taxes – and to avoid damaging their reputation.

The dividend stripping in question works something like this: Foreign investors lend shares they own in companies to German banks for a few days around the date a dividend is to be handed out. That allows them to claim back a 25-percent capital-gains tax from the authorities – a rebate that is actually reserved only for domestic investors. The German bank and the foreign investor then share the tax proceeds that have been refunded.

Although it is difficult to estimate how much tax revenue is lost in this way, it is thought to total several hundred million euros per year.

The German government doesn’t seem to mind. The order by the state of Hesse was acting on a similar decision at the federal level that has drawn the ire of many politicians in the past few days. A November 11 letter from the federal finance ministry, obtained earlier this week by Handelsblatt and a Bavarian media consortium, states that while dividend stripping deals are basically illegal, there are some key exceptions.

The ministry officials advised in their letter that trades between foreign investors and banks are legal and acceptable if the banks involved make a profit before deduction and reimbursement of the tax. That’s true in most of the cases – banks have usually achieved such a “positive pre-tax return” with these deals. The decree then defines a positive pre-tax return based on the gross dividend, i.e. including capital gains tax.

“Under these conditions, securities lending transactions in which banks are the borrowers in principle always show a positive pre-tax return. This wording means that the issue of such trades has been resolved and the deals will be legalized,” said Christoph Spengel from the university of Mannheim.

The state of Hesse, which has more banks than any other German state, quickly jumped on the finance ministry’s advice, issuing its decree on November 18 ordering the tax authorities’ auditors to stop investigating banks that engaged in the practice.

“Hesse's action reveals the cloak-and-dagger approach used by the German finance ministry...as a result of unscrupulous chumminess with banks.”

Norbert Walter-Borjans, Finance minister, North Rhine-Westphalia

The fact that Hesse took such a concrete action just a few days after the ministry’s circular was published outraged Norbert Walter-Borjans, finance minister of the German state of North Rhine-Westphalia, who has taken a lead role in vowing to fight the finance ministry’s decision.

“Hesse’s action reveals a cloak-and-dagger approach used by the German finance ministry to send its letter to the states ahead of the consultation requested by NRW, as a result of unscrupulous chumminess with banks,” said Mr. Walter-Borjans, a member of the center-left Social Democratic Party that is in coalition with Chancellor Angela Merkel’s Christian Democrats at the federal level.

Even before the meeting, Mr. Walter-Borjans had expressed reservations on behalf of the conference of state finance ministers. That Hesse’s finance minister is now attempting to pass off his actions as a show of strength against banks that were involved “makes a mockery of all decent taxpayers,” Mr. Walter-Borjans said.

The federal finance ministry has firmly rejected the allegations. It said the letter of November 11 related to a judgment of the federal fiscal court on a case involving a structured securities lending transaction – not the dividend stripping deals known as “cum/cum” transactions.

“So-called cum/cum transactions are not addressed,” the ministry said in a statement, adding that Mr. Walter-Borjans had missed his opportunity to discuss his concerns at a meeting of state finance ministers on November 10. The circular was sent out the following day, “so that the tax offices would be able to suspend the impending lapse of the statute of limitations at the end of the year in time for ongoing cases classified as abuse of tax systems.”

The ministry said that the majority of the federal states had also been in favor of its decision.

That’s not how everybody sees it. Some participants in the negotiations told Handelsblatt that the key meeting with heads of tax departments was a set-up. The federal ministry of finance incorporated a completely unnecessary sentence into its circular that allows states to grant banks a license for cum/cum deals. The states whose public-sector banks (“Landesbanken”) are said to have been involved in these trades then followed the federal finance ministry’s line, they say.

According to information received by Handelsblatt, North-Rhine Westphalia, Lower Saxony, Brandenburg and Mecklenburg-Western Pomerania voted against the license, while Saarland, Hamburg and Schleswig-Holstein abstained. The other nine states are said to be where the Landesbanken are based that participated in the tax tricks.

Mr. Walter-Borjans plans to make cum/cum trades a major topic of discussion at next week’s conference of state finance ministers. With the controversy coming as the government heads into a federal election year in 2017, he has received support from the national SPD party in Berlin, which is in a federal coalition government with Chancellor Angela Merkel’s CDU party.

“If current tax proceedings are to be concluded without properly checking whether additional payments need to be requested, it would be a scandal,” said Carsten Schneider, deputy floor leader of the SPD parliamentary group in the Bundestag. “I call on the federal ministry of finance to amend the circular and give the tax authorities clear instructions to examine all cases in which the aim was to avoid tax.”


Martin Greive is a correspondent for Handelsblatt based in Berlin. Sönke Iwersen leads Handelsblatt team of investigative reporters. Volker Votsmeier is an editor with Handelsblatt’s investigative reporting team. To contact the authors: greive@handelsblatt.comiwersen@handelsblatt.com and votsmeier@handelsblatt.com.

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