Hessian tax court rules on cum/ex, draft law on cum/cum

The judiciary and the federal government have dealt with cum/ex and cum/cum transactions. In the public debate, these terms are mentioned in the same breath. However, they concern different players and have different tax implications. This article aims to clarify the terminology.

Double counting for cum/ex

The abuse of cum/ex transactions has rightly caused great displeasure not only among experts, but also among the general public. As a result, capital gains tax, which was only paid once, was refunded several times. This was possible because share transactions involving foreign players were carried out around the dividend record date, which resulted in tax certificates being issued twice. This practice was already cancelled by law in 2012. Now a parliamentary committee of enquiry is investigating the involvement of the government, the financial administration and the banking supervisory authority. The accusation is that the situation was already known long before 2012 and nothing was done.

In its decision of 10 February 2016 (case no. 4 K 1684/14), the Hessian Tax Court has now set a narrower framework for these transactions. The decision was based on a case in which a bank bought shares over the counter before the dividend record date (cum) and these were only delivered after the record date without a dividend (ex). The bank nevertheless wanted the capital gains tax refunded and sued the tax office after it refused.

The Hessian tax court ruled that beneficial ownership of shares is generally not acquired upon conclusion of the agreement under the law of obligations, but only at the time of delivery of the shares. Furthermore, the determination of the raised capital gains tax, which is a prerequisite for a refund. This means that the tax is not levied as soon as the net dividend is paid out; a further prerequisite is that the custodian bank has also received the gross dividend. In cases of doubt, this must be proven by the purchaser of the shares who wishes to offset the capital gains tax. In cases where shares are acquired off-market including a dividend entitlement (cum) but, contrary to the agreement, are not delivered until after the dividend record date (ex), this proof can only be provided with a professional certificate.

Cum/cum leads neither to tax loss nor to double crediting

However, lumping cum/cum transactions into the same category oversimplifies the problem. In these transactions, shares held by a foreign, typically tax-exempt investor (such as insurance companies, pension schemes, foundations) in Germany are sold to a German buyer before the dividend record date.

The background to this is that under double taxation agreements, dividends are generally taxed at source and therefore in the country of the distributing company. Foreigners who have no other income in Germany can therefore not offset the German capital gains tax against their tax liability - unlike tax residents. To avoid this, the German buyer should be the owner of the share at the time of the inflow - but only then - so that he can then offset the capital gains tax paid against his tax. Otherwise, the capital gains tax would become definitive. After the dividend record date, the German buyer then sells the shares, which have generally fallen in value, back to the foreign investor.

The German government now wants to curb cum/cum transactions. Stricter requirements, which are being presented as part of the Investment Tax Reform Act, are intended to make the transactions more difficult. On the one hand, according to a draft bill, the domestic buyer of shares must hold the shares for 45 days around the dividend record date. On the other hand, the buyer may only hedge the risk of a loss in value of the shares until resale up to a maximum of 70%. It is foreseeable that this will make cum/cum transactions more difficult, but by no means curb them. The customary 100% hedging is also possible by involving third parties and it will not be impossible to meet the deadline.

If the legislator really wanted to curb this practice, an international approach would be necessary, as these transactions take advantage of the fact that capital gains are regularly taxed in the country of residence under double taxation agreements and the seller of the shares is generally tax-exempt there - including typical players in Germany. Dividends, on the other hand, are taxed in the source country under these agreements. Taking this into account in tax planning is not tax trickery, but common sense. The tax exemption of non-profit organisations and institutions that serve to provide security and retirement provision in the country of residence is politically desirable and would be counteracted by a definitive capital gains tax.

Markus Betz is a lawyer and tax consultant at TAXGATE, a tax law firm specialising in transactions, investments and tax compliance. More on this topic in the Monitor report on Cum/Ex and Cum/Cum with TAXGATE interview.