The German Parliament voted Thursday to end a trading strategy that helps foreign investors, many of them Americans,avoid an estimated $1 billion or more a year in taxes on dividends paid by German companies.
The trades were exposed in a joint ProPublica investigation last month with The Washington Post and German news outlets Handelsblatt and Bayerischer Rundfunk. The report prompted widespread outrage among German lawmakers, some of whom called the maneuver “criminal.”
This week’s vote effectively shuts down the transactions in Germany, which had been the biggest market for such trades. They live on in more than 20 other countries across Europe and other nations where authorities attempt to collect taxes on dividends.
While German lawmakers closed the spigot on future tax losses, it remains unclear if tax officials there will be able to recoup billions of lost revenues from previous years.
Prior to Thursday’s vote, experts in Germany were divided over whether the transactions — engineered by large multinational banks to benefit institutional investors at the expense of German taxpayers — were illegal under existing law.
The new legislation does not ban the transactions but it makes them impossible to execute the way they’ve been traditionally done — as a riskless short-term transaction to avoid taxes.
The trades, known as dividend arbitrage, help foreign investors avoid taxes on dividend payments by lending out their German stock holdings so they do not appear on their books at dividend time. The borrowers are German banks or funds that don’t have to pay the 15 percent tax that typically applies to foreign investors.
These so-called “div-arb” loans usually last just a few days around dividend time. The shares are then returned and the the short-term borrowers apply to German authorities for a refund of the taxes withheld. The tax savings are then split among the investors and middlemen who arranged the deals, giving them an extra slice of dividend payments that would otherwise go to German taxpayers.
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Our story revealed that Commerzbank — Germany’s second-biggest bank — played a key role in div-arb deals despite being part-owned by German taxpayers due a bailout. That disclosure, based on confidential documents outlining the trades, enraged lawmakers and prompted investigators in Frankfurt to open a probe into the bank’s involvement in div-arb.
Reacting to the piece, the Parliament tightened some provisions of reform legislation that had been proposed by Germany’s Finance Ministry. Lawmakers attached 24 changes to the law to make it even more punitive to investors who carry out such trades, driven in large measure by outrage over Commerzbank’s role.
The disclosures about Commerzbank created “enough pressure in the Parliament to sharpen the bill proposed by the Finance Ministry,” Gerhard Schick, deputy chairman of the Parliament’s finance committee, said during debate on the measure.
As originally proposed by the Finance Ministry, the law would aim to make div-arb deals uneconomical by requiring investors to stretch out their loans to at least 45 days and to have at least 30 percent of the value of their investment at risk during that time. Now, investors participating in div-arb will have to have at least 70 percent of their investment at risk.
Australia implemented a similar change to halt the practice there. Germany's law is set to take effect retroactively to January 1.
Wolfgang Schauble, Germany’s finance minister, has previously criticized the deals but said that he cannot seek to recover past taxes lost to div-arb. Tax authorities are, however, going after banks who participated in an even more nefarious form of div-arb, known as cum/ex trading.
In that arrangement, investors reclaimed even more dividend taxes than had actually been withheld by the German government. Cum/ex deals were outlawed in 2012 and are now coming back to haunt many of the country’s biggest banks.
As Germany bids farewell to div-arb, however, its neighbors should take note: France, Sweden, Norway and Italy, among others, remain active markets for the trade, according to documents obtained by ProPublica.
This article was written by Cezary Podkul, with reporting contributed by Arne Meyer-Fünffinger and Pia Dangelmayer of Bayerischer Rundfunk in Berlin and Munich. Translation contributed by Jennifer Stahl.