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Cum fake trading: close tax loopholes

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07 October 2020

Cum fake trading: close tax loopholes (press release)

Short of cum ex and cum cum trading, cum fake transactions also lead to a significant loss of tax revenue. Cum fake trading is about filing fraudulent documents and illegally collecting a capital gains tax refund. “Cum fake transactions constitute cases of major fraud and use loopholes in the current tax refund regime,” Kay Scheller, President of the German SAI, said when presenting the audit report to the public. “The legislator urgently needs to prevent this specific type of tax fraud. This is not only a matter of tax justice. Such refunds fraudulently draw on the German tax authorities’ money.”

Thus far, the German legislator has failed to prevent cum fake trading and any malpractice in connection with dividend withholding tax refunds. As a result, institutional investors stand to illegally cash in on properly entitled investors (usually retail investors) who forego demanding the refund, whether through ignorance or because they dread the red tape involved. The fraudulent tax refunds actually constitute a loss of the German taxpayers’ money.

In cum fake trading, (institutional) investors use U.S.-traded American Depository Receipts for German stocks, with such stocks not yet being deposited (pre-released ADRs). Albeit not being the beneficial owner of the stocks, they request a tax voucher in order to file for a tax refund from the Federal Central Tax Office. The eligible stocks, however, are held by investors who for diverse reasons opted not to claim a refund.

Major loopholes in the German tax refund procedures have paved the way for abusive practices. The procedure in place does not permit unequivocally establishing the identity of the eligible investor who paid capital gains tax. This anonymity is inherent in the system and gives rise to malpractices such as cum fake trading.

We recommended considering the pros and cons of implementing the TRACE system (Treaty Relief and Compliance Enhancement) initiated by the OECD in 2006. TRACE provides for a capital gains tax relief at source on portfolio investments. TRACE could replace the downstream tax refund procedure currently used in Germany which is susceptible to abuse. The TRACE system does without tax vouchers that so far facilitated fraudulent tax refunds. “Tax refund pots will be smaller and investors entertaining inimical intentions can take less money out of them”, Kay Scheller said.

We provided information on this topic to the parliamentary Budget Committee in our advisory report on “Cum fake trading – risks linked to refunding capital gains taxes pursuant to applicable double taxation agreements”.

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