Bob Currie provides a comparative update on the efforts of national authorities to eliminate dividend tax reclamation fraud and to seek recovery of funds lost through cum-ex and cum-cum trading
In February, the Danish tax authority returned to the UK courts to reactivate its efforts to recover losses that it says it sustained through cum-ex fraud committed by founder of Solo Capital Partners Sanjay Shah and other parties.
The UK High Court in London previously rejected a claim by Skatteforvaltningen, the Danish tax authority (‘Skat’), against Dubai-based trader Sanjay Shah on the grounds that the claim was inadmissible in a UK court (Skatteforvaltningen v Solo Capital Partners LLP and ors, 2021, EWHC, 974).
It did so citing a longstanding legal principle, referred to as Dicey Rule 3 (see below), that prevents courts from hearing cases brought by foreign authorities to enforce their own tax legislation.
However, Skat has succeeded in its appeal, with Sir Julian Flaux, chancellor of the High Court, finding that the claims of Skat against the alleged fraud defendants could proceed to the next phase of inquiry.
In its appeal, Skat maintained that its claims were not an attempt to recover unpaid tax but that, instead, it was a victim of fraud that was primarily orchestrated from, or conducted through, legal entities based in England.
In forming its argument that this was a case of fraud, Skat’s legal team noted that the defendants did not hold shares in any of the Danish companies, they had not received dividends from those companies and, consequently, there could be no withholding tax (WHT) applied on dividend payments from those companies to the defendants. With this in mind, there was no WHT entitlement to refund by the tax authority to these persons.
In upholding Skat’s appeal, Sir Julian Flaux judged that the claim by Skat against the defendants does not constitute a claim for unpaid taxes or a claim to recover tax. Rather, it is a claim “to recover monies which had been abstracted from Skat’s general funds by fraud”.
“The alleged fraud defendant’s submission that the claim to the refund is still a claim to tax is simply wrong as a matter of analysis and the judge fell into error in accepting that submission,” said the judgement ([2021] EWHC 974 (Comm), parg 128).
On bringing the case, the Danish State Prosecutor for Serious Economic and International Crime, Per Fiig, formally charged Sanjay Shah, a UK national resident in Dubai, and another British national who is resident in the UK, with having defrauded the Danish state of more than DKK 9 billion (US$1.5 billion).
Per Fiig alleges in a public statement on 7 January 2021 that the two defendants committed “cynical and meticulously planned fraud” in a “well-designed and organised fraud scheme” where it submitted more than 3000 applications to unlawfully receive dividend tax refunds from the Danish exchequer.
The Danish state prosecutor alleges that these unlawful applications for dividend tax refunds involved the formation of 24 Malaysian companies and 224 US pension plans. It also included more than 70 companies incorporated in locations including the British Virgin Islands, the Cayman Islands, the United Arab Emirates and the UK.
In outlining its original case, the prosecutor said that these two British nationals are suspected of fraud of a particularly aggravated nature — in contravention of section 279, read with section 286(2) of the Danish Criminal Code. At the time of application, the maximum penalty under Danish law for these offences was eight years’ imprisonment. However, the State Prosecutor indicated that owing to the severity of the cases, the size of the amount, the length of the period for which these cases were committed and the organised nature of the fraud, the prosecutors would apply a special section of the Criminal Code through which the maximum penalty could be increased to 12 years’ imprisonment.
Fight for recovery
A primary focus during the initial 4-day trial, conducted in the High Court of England and Wales in April 2021 under Justice Andrew Baker, was that the English courts will not hear claims by foreign states which represent extra-territorial assertion of a state’s sovereign powers.
Dicey Rule 3 is a substantive rule of English law (and also Cayman and BVI law) and applies irrespective of whether English law will govern the merits of the claim more generally. According to Harneys, the BVI and London-based law firm, it is for the English (or Cayman, or BVI) Court to decide whether a claim falls within the rule. For example, in the Skat proceedings, the issue of whether Skat’s claim fell within the rule was a question of English, rather than Danish, law.
In finalising his judgement in the case of Skat’s appeal, chancellor of the High Court Sir Julian Flaux ruled:
“In my judgement, this claim against the Skat defendants is not a claim to unpaid tax or a claim to recover tax at all. It is a claim to recover monies which had been abstracted from Skat’s general funds by fraud. The alleged fraud defendants’ submission that the claim to the refund is still a claim to tax is simply wrong as a matter of analysis and the judge [Andrew Baker] fell into error in accepting that submission.” (op.cit., parg. 128)
Furthermore, because there is no unsatisfied claim to tax, the “essential feature” of the revenue rule [as Lord Mackay described it in Williams & Humbert] is absent. The argument by the alleged fraud defendants that the claim is precluded by the wider sovereign powers rule within Dicey Rule 3 is also misconceived, according to Chancellor Julian Flaux (parg 129).
The Chancellor finds that in bringing a claim to recover funds that it has lost as a result of alleged fraud, Skat is not doing an act of a sovereign character or enforcing a sovereign right. “Rather it is making a claim as the victim of fraud for the restitution of monies of which it has been defrauded, in the same way as if it were a private citizen. I very much doubt whether payments induced by fraudulent misrepresentation can properly be described as sovereign acts [since] the effect of the fraud is to render those payments a nullity or invalid,” says the court judgement (parg 130).
He continues: “in revoking the refunds and seeking to recover the monies, Skat is not seeking to vindicate those acts even if they were sovereign, but to invalidate them.” (ibid)
Skat’s legal team at One Essex Court were approached for comment on these findings, but were unwilling to respond at this time.
To add further substance to its ability to pursue recovery from Sanjay Shah, and any other tax fraud defendants resident in the UAE, Denmark signed an extradition treaty with the UAE on 17 March 2022. Outlining the rationale for this action, Danish Minister of Justice Nick Hækkerup says:
“We have seen examples of suspected perpetrators hiding under warmer skies, and thus avoiding prosecution and being held accountable in this country for their actions. This applies both in the cause of fraud with dividend tax and in connection with the wreckless driving that cost a police officer his life in Langebro in 2019, where the suspected perpetrator later fled to Dubai.
“As Minister of Justice, I find that completely unacceptable. This agreement will hopefully enable us to get the suspected perpetrators to the country, so that they can be prosecuted in Denmark,” he concludes.
In establishing the treaty, the Danish government noted that a number of other EU countries have recently established similar agreements with the UAE, including The Netherlands and Belgium, which entered into extradition and mutual legal aid agreements with the UAE in 2021.
Cross-jurisdiction comparisons
Salomé Lemasson, head of EU business crime and regulatory practice at Rahman Ravelli notes that since 2018, Skat, alongside the German authorities, has been one of the most active and creative European authorities in terms of pursuing cum-ex related cases. Skat has filed more than 500 legal actions against businesses and individuals in Denmark, the UK, Germany, the US, and other countries including Dubai, Canada and Malaysia, in its efforts to recover close to US$2 billion in losses that it says it is owed due to cum-ex or cum-cum fraud. Skat estimates that it may spend up to US$380 million by 2027 in pursuing these cases through the UK legal system.
Beyond the UK, there has been an increase in enforcement actions in Germany after successful prosecutions were confirmed in the German courts during the summer of 2021.
Specifically, in Germany, two UK bank employees were given suspended sentences in March 2020 following their role in cum-ex trading activities.
In June 2021, a former executive at German private bank MM Warburg was given a 5.5-year custodial sentence by judges in Bonn, having been found guilty of aggravated tax evasion linked to cum-ex trading.
This difference in sentencing is mainly explained by the significant co-operation of the two UK bank employees with the investigation, resulting only in a suspended sentence.
Also, in February 2022, another former MM Warburg employee was sentenced in Bonn to 3.5 years of gaol time, having been found guilty on two charges of aggravated tax evasion linked to cum-ex schemes.
Cum-ex hearings in the German Finance Courts
Law firm Rudolph Rechtsanwälte observes that, in Germany, a ruling involving cum-ex claims against US Fund KK Law Retirement Plan Trust (Cologne Finance Court, file number 2 K 2672/17) can be regarded as a test case for a sizeable number of similar disputes currently pending before the Federal Central Tax Office (Bundeszentralamt für Steuern).
These were based on share transactions that had been carried out off-exchange as part of a short sale. The transactions were executed before the dividend record date when the shares had a claim to the expected dividend (“cum dividend”) and ex-dividend shares were delivered to close out the transaction after the dividend record date. The court was asked to adjudicate whether the share purchaser was entitled to a refund of capital gains tax.
In ruling on this case, the 2nd Senate of the Cologne Finance Court concluded that the share purchaser was not entitled to a CGT refund subsequent to the transaction. In the event of an off-exchange short sale, the court notes, the purchaser of the shares would not become the beneficial owner of the shares [to be delivered at a later date] by concluding the purchase agreement. It was therefore not entitled to offset the capital gains tax withheld and paid in respect of the dividend.
Similarly, the Kassel Fiscal Court, in a ruling of 10 February 2016 (case no. 4 K 1684/14), stated that in an over-the-counter share purchase, “the buyer does not become the owner of the shares for tax purposes at the time when the contract was concluded”. The Court argued that the purchaser could only become the owner for tax purposes when the possession of the shares is transferred [ie at settlement date for the transaction], which in the case in question took place after the date of the dividend distribution.
In a Kassel Fiscal Court ruling of 10 March 2017 (case no. 4 K 977/14), this legal opinion in case 4 K 1684/14 regarding over the counter cum-ex transactions was confirmed also for the case of stock exchange transactions that are settled via a central counterparty.
Alongside these cases, German tax and prosecution authorities continue to investigate more than 1000 businesses and individuals in connection with alleged tax violations linked to cum-ex trading.
In enforcing these actions, there has been cooperation between financial regulators and tax authorities across jurisdictions, particularly within Europe. In September 2021, for example, The Swiss Federal Office of Justice confirmed that it had approved extradition of Hanno Berger, German tax expert and lawyer accused of defrauding the German tax authorities through trading and tax improprieties linked to ‘cum-ex’.
Berger, who has lived in Switzerland since 2012, was handed over to German police in Konstanz at the end of February 2022 and is expected to appear in court in early April according to a statement from German prosecutors. Berger has repeatedly rejected the charges and opposed his extradition to Germany through his legal representatives.
In France, the tax authorities are also scrutinising a large volume of securities transactions and are currently running investigations into several French banks for cum-cum related transactions. It is unclear at this time whether these investigations will result in criminal proceedings.
In 2018, a criminal complaint was filed by a citizens’ collective relating to allegations of tax fraud in relation to cum-ex trading. This case, which is being investigated by the National Financial Prosecutor (PNF), is currently ongoing. “Owing to the French criminal system, there is no visibility as to what is happening during a preliminary investigation,” says Rahman Ravelli’s Lemasson.
For clarification, France no longer operates a system where withholding tax on dividend payments is reclaimed through presentation of a tax certificate, issued via a depository bank, to the tax authorities.
Consequently, claims against defendants filed in the French courts have targeted alleged cases of dividend arbitrage exercised through ‘cum-cum’ schemes — and not, as in Germany, the UK, the US and some other jurisdictions, as cases of ‘cum-ex’ activity. The official position of the French tax authorities is that tax fraud through ‘cum-ex’ schemes is not supported under French law.
Another difference between France and Germany, notes Lemasson, is that the threshold to establish criminal intent is higher when having to establish criminal tax fraud (under French criminal law) as opposed to criminal tax evasion (under German law).
Furthermore, bilateral tax treaties that govern dividend arbitrage trading in cum-cum scenarios were written some years ago and do not provide clear guidance around the treatment and legality of cum-cum activities.
Cost to the european exchequer of cum-cum trading fraud
Through analysis conducted in partnership with the research network CORRECTIV, the University of Mannheim’s Prof Dr Christoph Spengel estimates that potential tax revenue losses owing to cum-cum transactions in 10 countries amount to €141 billion between 2000 and 2021, according to conservative estimates.
This estimate of the tax revenue loss is based on two approaches. The first is founded on the assumption that a fraction of foreign shareholders improperly avoided the capital gains tax levied on dividends through cum-cum transactions with domestic “intermediate acquirers” either in the form of securities lending or as a sale of the repurchase transaction (p 2)
It chooses an estimate based on a “conservative benchmark” which assumes that 50 per cent of foreign shareholders engage in cum-cum transactions.” This, it claims, is based on investigative research by CORRECTIV, along with its discussions with tax authorities and market participants, reinforced by plausibility checks conducted by the University of Mannheim.
A second approach is based on an estimate that 15 per cent of the capital gains tax levied on dividends was improperly avoided through cum-cum transactions. In guiding this assumption, the researchers identify a “very short-term and short-lived increase” in security ownership of domestic banks from close to 0 per cent to a maximum of 15 per cent during the dividend payment period dates for some securities.
Based on these assumptions, the potential tax revenue loss is calculated as either: (i) 50 per cent of dividend payments attributable to foreign shareholders; or (ii) 15 per cent of the total dividend payment, each multiplied by the CGT rate on dividends specified in the double taxation treaty (DTT). The reduced tax rate in DTTs is generally 15 per cent.
Alongside the “conservative estimate”, the paper estimates the potential revenue loss if foreign shareholders were not entitled to the reduced DTT CGT rate. This predicts a potential tax revenue loss of between €63 billion (15 per cent of shares are used in cum-cum transactions, applying the DTT CGT rate) and about €235 billion (50 per cent of foreign held shares are used in cum-cum transactions, applying the local CGT rate) for all countries for the 2000 to 2020 period.
Concluding thoughts
While these legal cases illustrate how some tax authorities are stepping up their efforts to recover losses sustained through cum-ex fraud and to prosecute the alleged perpetrators, few jurisdictions appear to have passed substantive legislative changes to eliminate tax loopholes that enable fraudulent WHT reclaim schemes to operate.
The focus to date, rightly or wrongly, appears to be on chasing the fox, rather than securing the chicken house. Both appear to be fundamental if the financial authorities wish to eliminate leakage through cum-ex and cum-cum fraud.
The European Securities and Markets Authority (ESMA), in its September 2020 paper, Final Report On Cum/Ex, Cum/Cum and Withholding Tax Reclaim Schemes, identifies just five EU Member States — Austria, Belgium, Finland, France and Germany — that, at the time of publication, had made such legislative amendments.
In representing persons served with cum-ex charges, defence lawyers have frequently highlighted that cum-ex transactions were common practice — perhaps accepted practice — at the time they were executed. For example, UK law firm Lupton Fawcett states:
“Such activities were commonplace and entered into as part of sensible tax planning. Most parties in cum-ex trades acted on the advice of lawyers and accountants who genuinely believed that they were simply taking advantage of a legitimate legal loophole. In fact, it is arguable that, as tax authorities and governments were aware of cum-ex trading for many years and took no action to stop it, the practice had been accepted.”
Significantly, this firm also notes that “despite the fact that the transactions were not illegal, or carried out dishonestly at the time, the actions of parties involved in cum-ex trading are now coming under increased scrutiny, and a retrospective reanalysis of activity is taking place.” Lupton Fawcett declined our request for additional comment.
The law is often complex in these areas, as Rahman Ravelli’s Salomé Lemasson has observed above — and there are significant differences from one jurisdiction to another in the threshold that must be met to establish criminal intent.
In the UK, fines have been applied to firms by the Financial Conduct Authority for failure to meet anti-moneylaundering requirements and for deficiencies in their financial control frameworks. In May 2021, for example, the FCA fined Sapien Capital, an investment firm that had provided brokerage services to Sanjay Shah’s Solo Capital, for “serious failings of its financial control systems”.
Six months later, the UK financial regulator also fined Sunrise Brokers for “serious financial control failings” that facilitated moneylaundering and fraudulent trading by Solo Capital, which is now in financial administration.
ESMA notes that Denmark has not passed legislative changes specifically targeting WHT reclaim schemes, but since 2015 it has “substantially strengthened its administration of dividend refunds, including a significant staff increase and enhanced procedures”. Furthermore, the Danish Minister of Taxation has announced a legislative change, including a new dividend refund model built on relief at source and a pre-registration procedure (ESMA, op.cit., parg 57).
It is perhaps damning that ESMA’s survey of EU national competent authorities (NCAs) provides little evidence of coherent dialogue between policymakers and supervisors around how WHT reclaim fraud is applied and how it can best be monitored and prevented.
The majority of NCAs that responded to ESMA’s questionnaire indicated that they were not aware of any final decision by a public authority declaring the illegality of such schemes, while at the same time they “could not exclude that any such decision may have been taken in their respective Member State” (parg 69). “Information on court decisions declaring the illegality of multiple WHT reclaim schemes in the Member States appears to be limited,” says the ESMA report (parg 68).
This knowledge gap may be because NCAs do not believe that efforts to detect cum-ex and cum-cum fraud schemes are their responsibility, but rather the responsibility of the national tax authorities.
Notwithstanding, ESMA’s inquiry confirmed that, at the time of publication, no NCA was conducting systematic market surveillance to detect multiple WHT reclaim schemes. Rather, “their market surveillance systems and procedures are focused on the detection of market abuse,” it says. ESMA did note, however, that the UK’s FCA has been given an “extended remit by national law”, through which it can use transaction reporting data and the other regulatory information not only to detect potential market abuse, but also for purposes of detection of financial crimes in a broader sense (parg 86).
More broadly, ESMA indicates that it has expanded its analysis of securities lending data to cover all EU Member States. This, it says, is set up particularly to assess the presence of significant variations in securities lending markets across the dates where some Member States passed legislative changes to halt multiple WHT reclaim schemes (parg 18).
