ESMA: Regulators and tax authorities must unite to thwart cum-ex
25 September 2020 Frankfurt
Image: Pixel-Shot / Adobestock.com
Securities markets regulators should be empowered to share information with tax authorities to crack down on cum-ex-related tax fraud, says the European Securities and Markets Authority (ESMA).
National regulators have been grappling with the issue of cum-ex tax fraud for more than a decade which is thought to have deprived tax authorities across Europe of an estimated 鈧�55 billion.
The fundamentals of a cum-ex trade require a complex process of borrowing and shorting securities over a dividend period in such a way that allows multiple parties to claim withholding tax exemptions on a single asset.
In its final report following a two-year review of how national competent authorities (NCA) can improve their ability to detect withholding tax reclaim schemes 鈥� known as cum-ex, a name derived from the Latin words for 鈥榳ith鈥� and 鈥榳ithout鈥� 鈥� ESMA emphasises that any response should be 鈥渕ainly sought within the boundaries of the tax legislative and supervisory framework鈥�.
Among the suggestions, ESMA recommends legislative changes to the Market Abuse Regulation to remove the legal limitations on NCAs exchanging information acquired from other regulators with tax authorities.
Additionally, a common legal basis should be developed to ensure a consistent and convergent approach on the exchange of information directly acquired by NCAs in their supervisory activity with tax authorities, the authority suggests.
鈥淲hile halting these schemes seems to be primarily dependent on changes to tax legislation, ESMA considers that increased cooperation between NCAs and tax authorities across the EU would be an important step in identifying and deterring abusive schemes,鈥� says ESMA鈥檚 chair Steven Maijoor.
ESMA鈥檚 report has now been submitted to the European Parliament for review.
There has been a spate of criminal and commercial court cases in Germany, the worst affected market, this year which led to being convicted of criminal tax avoidance and handed suspended sentences in March.
Earlier this week Frankfurt's regional court ruled that to reimburse a 鈧�167 million tax bill related to cum-ex deals paid by MM Warburg over a decade ago.
Cum-ex decrypted
Market FinReg鈥檚 Seb Malik breaks down a cum-ex trade.
The key chain is when the day before a dividend entitlement date, an entity (S) short sells the shares with (鈥渃um鈥�) dividends to a buyer (B) for T+2 settlement. After the dividend entitlement date, S buys the shares without (鈥渆x鈥�) dividends from entity O and delivers it to B for immediate settlement, thereby allowing S to settle his initial trade with B.
Since S鈥檚 initial short trade was cum dividend, S pays dividend compensation to the effect that B receives the share with the dividend payment. O was the holder on record on the record date and so legitimately claims its own tax rebate.
Following B鈥檚 receipt of the shares and dividends compensation, B鈥檚 custodian bank issues a tax certificate which allows B to claim withholding tax.
Thus, both B and O have claimed a withholding tax rebate while only O has actually paid. This is where the profit comes from.
A is also available.
National regulators have been grappling with the issue of cum-ex tax fraud for more than a decade which is thought to have deprived tax authorities across Europe of an estimated 鈧�55 billion.
The fundamentals of a cum-ex trade require a complex process of borrowing and shorting securities over a dividend period in such a way that allows multiple parties to claim withholding tax exemptions on a single asset.
In its final report following a two-year review of how national competent authorities (NCA) can improve their ability to detect withholding tax reclaim schemes 鈥� known as cum-ex, a name derived from the Latin words for 鈥榳ith鈥� and 鈥榳ithout鈥� 鈥� ESMA emphasises that any response should be 鈥渕ainly sought within the boundaries of the tax legislative and supervisory framework鈥�.
Among the suggestions, ESMA recommends legislative changes to the Market Abuse Regulation to remove the legal limitations on NCAs exchanging information acquired from other regulators with tax authorities.
Additionally, a common legal basis should be developed to ensure a consistent and convergent approach on the exchange of information directly acquired by NCAs in their supervisory activity with tax authorities, the authority suggests.
鈥淲hile halting these schemes seems to be primarily dependent on changes to tax legislation, ESMA considers that increased cooperation between NCAs and tax authorities across the EU would be an important step in identifying and deterring abusive schemes,鈥� says ESMA鈥檚 chair Steven Maijoor.
ESMA鈥檚 report has now been submitted to the European Parliament for review.
There has been a spate of criminal and commercial court cases in Germany, the worst affected market, this year which led to being convicted of criminal tax avoidance and handed suspended sentences in March.
Earlier this week Frankfurt's regional court ruled that to reimburse a 鈧�167 million tax bill related to cum-ex deals paid by MM Warburg over a decade ago.
Cum-ex decrypted
Market FinReg鈥檚 Seb Malik breaks down a cum-ex trade.
The key chain is when the day before a dividend entitlement date, an entity (S) short sells the shares with (鈥渃um鈥�) dividends to a buyer (B) for T+2 settlement. After the dividend entitlement date, S buys the shares without (鈥渆x鈥�) dividends from entity O and delivers it to B for immediate settlement, thereby allowing S to settle his initial trade with B.
Since S鈥檚 initial short trade was cum dividend, S pays dividend compensation to the effect that B receives the share with the dividend payment. O was the holder on record on the record date and so legitimately claims its own tax rebate.
Following B鈥檚 receipt of the shares and dividends compensation, B鈥檚 custodian bank issues a tax certificate which allows B to claim withholding tax.
Thus, both B and O have claimed a withholding tax rebate while only O has actually paid. This is where the profit comes from.
A is also available.
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