As an aftermath to recent fiscal court decisions on cum/cum transactions, the German Federal Ministry of Finance ("BMF") has reconsidered its guidance on the transfer of beneficial ownership in securities lending transactions and in cum/cum-transactions.
On 11 November 2016, the BMF published the first guidance (the "Old Beneficial Ownership Decree") which summarized that according to the generally applicable principles in securities lending transactions it was the borrower and not the lender to whom the economic ownership with respect to the securities shall be allocated. In a subsequent BMF-decree dated 17 July 2017 on the tax treatment of cum/cum transactions (the "Old Cum/Cum-Decree") the BMF acknowledged that in cum/cum transactions generally the beneficial ownership was transferred from the lender to the borrower but then applied the German General Anti-Avoidance Rule, Section 42 of the German Fiscal Code (the "GAAR"), and, as a consequence, denied the tax-induced part of the credit or refund (3/5) of German withholding tax ("WHT").
Recent decisions by fiscal courts
After the first decision of the Federal Fiscal Court dated 18 August 2015 on securities lending transactions in which the Federal Fiscal Court denied "by way of an exception" the transfer of the economic ownership with respect to the shares from the lender to the borrower, in 2020, there has been a series of fiscal court decisions dealing with the transfer of beneficial ownership in securities lending transactions and the application of the GAAR. In a decision dated 28 January 2020, the Fiscal Court of the State of Hesse denied the transfer of beneficial ownership with respect to two cum/cum transactions of a German corporation with reference to the concrete contractual arrangement and therefore completely denied its entitlement to a refund or credit for WHT on the dividends received on the German shares, and additionally applied Section 42 AO with respect to the question whether the compensation payments can be deducted as business expenses.
Subsequently, the Fiscal Court of the State of Saxony-Anhalt in a decision dated 25 November 2020, and the Fiscal Court of Munich in a decision dated 14 December 2020 ruled on similar securities lending cases in which a German financial institution provided securities to a German corporation over the dividend date. The parties agreed in the securities lending agreement that the German corporation was obliged to compensate the German financial institution for any interest, dividend or other distributions paid on the securities. The courts denied the deduction of the compensation payments as business expenses at the level of the corporation on the grounds that it had not become the beneficial owner of the securities and consequently (from a tax perspective) had not received any business income from the securities and could therefore neither deduct the business expenses.
New guidance by the BMF dated 9 July 2021
On 9 July 2021, the BMF issued a new letter on economic ownership considerations with respect to securities lending (amending and replacing the Old Beneficial Ownership Decree) (the "New Beneficial Ownership Decree") and a new letter on cum/cum transactions (amending and replacing the Old Cum/Cum Decree) (the "New Cum/Cum Decree") which shall apply to all "open" cases:
New Beneficial Ownership Decree
In its New Beneficial Ownership Decree, the BMF still states that according to the generally applicable principles in securities lending transactions it is the borrower and not the lender to whom the economic ownership with respect to the securities is to be allocated in securities lending transactions, and that it is to be assessed on a case-by-case basis whether the securities that are lent to a borrower shall exceptionally remain to be allocated to the lender. However, the New Beneficial Ownership Decree no longer considers a positive return before taxes derived from the transactions as an argument for the transfer of beneficial ownership to the borrower or for the non-application of the GAAR. Instead, the New Beneficial Ownership Decree includes two "base cases" in which shares are lent over dividend date ("for tax reasons, in order to artificially create deductible business expenses") and in which the BMF concludes that the borrower did not become the beneficial owner of the shares, and additionally classifies the structure as abusive within the meaning of the GAAR and therefore the BMF denies any tax effects resulting from the transaction.
New Cum/Cum Decree
In its New Cum/Cum Decree (and in contrast to the Old Cum/Cum Decree), the BMF generally denies the transfer of beneficial ownership in cum/cum structures. The BMF substantiates this view with the same arguments that have already been mentioned in the recent fiscal court decisions. Additionally, after having denied the transfer of beneficial ownership, the New Cum/Cum Decree also applies the GAAR with respect to any other tax effects resulting from the transaction (and also if beneficial ownership was transferred to the borrower, Section 42 AO would have to be applied).
In a number of examples the BMF describes the implications of the parallel application of both economic ownership and anti-abuse considerations. The BMF states that the attempt to avoid a definitive WHT on dividends is abusive and leads to a tax benefit which is not intended by law. As a consequence, the dividend actually received by the borrower is for tax purposes attributable to the lender so that the borrower is not entitled to a credit or refund for the WHT at all and should neither be allowed to deduct any expenses relating to the transaction. Furthermore, the BMF explicitly points out that the notification and correction obligation of former tax assessments pursuant to Section 153 AO applies with respect to cum/cum situations if a taxpayer subsequently (but before the respective tax assessment is no longer amendable) recognises that he had incorrectly or incompletely declared any such structures in his tax declarations and that this may have led to the shortening of taxes. Unlike the old BMF letter, the New Cum/Cum Decree no longer includes any time limitation of its application.
Under the new decrees, every securities lending transaction will have to be reviewed on a case-by-case basis to determine whether the beneficial ownership in the underlying shares has been transferred and whether the GAAR may apply. With respect to cum/cum structures, the BMF seems to follow the recent fiscal court decisions and generally assumes that (i) beneficial ownership is not transferred and (ii) such structures constitute abusive structures. As a consequence, the BMF no longer just denies the "tax-induced" part of the credit or refund to the borrower, but (since the acquisition of beneficial ownership is denied) a refund or credit in total.
Furthermore, by applying the GAAR, any additional tax effects at the level of the borrower resulting from the transaction are disregarded. Therefore, it is – subject to any subsequent civil law implications between the parties – merely the borrower who has to face the consequences of the New Cum/Cum Decree. As regards the reference to a notification and correction obligation pursuant to Section 153 AO (which obviously shall put pressure on market participants), any domestic borrower which has participated in cum/cum structures or in comparable transactions and has received at least a partial tax refund or tax credit would have to review its tax declarations and consider a potential obligation to notify and correct the previous filings (to the extent they can still be amended). This holds even more true in light of the fact that the New Cum/Cum Decree no longer contains a time limitation but shall apply to all "open" cases.