The German Federal Fiscal Court (Bundesfinanzhof, BFH) published its long-awaited ruling on the legality of so-called "cum ex"-structures which may have led to multiple refunds of German withholding tax (WHT) that was paid only once. The ruling brings an end to a decades-long discussion which culminated in criminal convictions (see this earlier post) and now the extradition of the German tax attorney Hanno Berger, the alleged "mastermind" of such structures, from Switzerland to Germany where he is set to appear in court from April 2022 onwards.
The ruling is not only relevant for (historical) cum/ex structures, but also for the beneficial ownership assessment in other tax-driven structures such as cum/cum.
The facts of the case (simplified)
A US pension fund entered into single-stock future contracts in over-the-counter (OTC) transactions via EUREX. First, the pension fund acquired a long future shortly before the dividend date which was supposed to be settled physically shortly after the dividend date, meaning that the future contract contained the dividend entitlement (cum). In a second step, the pension fund acquired a short future to cover the long future but without dividend entitlement (ex). As intended, the prime broker settled the second future in cash. Subsequently, the pension claimed a full WHT refund from the Federal Tax Office based on Article 10(3)(b) of the German-US Double Taxation Treaty since the settlement of the long future was based on the "net dividend amount".
According to the facts found by the court of the first instance, the set-up of the pension fund's contractual obligations was essentially pre-determined by others such as the liquidity provider who advertised a return on investment of 15.72%. In its description of the facts, the BFH made no statement whether there were short sale transactions or foreign depository banks acting for the sell-side.
The BFH concluded that the pension fund could have claimed a WHT refund if it had been the beneficial owner of the shares (beneficial ownership criterion) and WHT had been deducted and withheld (WHT criterion). These requirements derived from domestic law but were also relevant under the treaty. Neither of them had, however, been met.
On the beneficial ownership criterion, the BFH raised several novel points and provided important clarifications:
- The BFH stressed that the active right to use the asset (aktive Nutzungsmacht) was a key criterion for the determination of beneficial ownership. This should be seen in addition to the traditional understanding of beneficial ownership as the right to exclude the legal owner from exercising its ownership rights.
- The beneficial ownership provision assumes that there can be only one beneficial owner ("Alternativity" in the words of the BFH, or sometimes called in literature the "Highlander Principle") and that the beneficial ownership must be derived from a legal owner. It is only possible to assume beneficial (and not legal) ownership if someone else is the legal, but not the beneficial, owner. Rather surprisingly in light of its own statement about the singularity of beneficial ownership, the BFH did not elaborate on who the beneficial owner actually was (given its conclusion that it was not the pension fund).
- In determining whether the pension fund had acquired beneficial ownership, the BFH did not limit itself to looking at each transaction individually, but considered the overall arrangement of pre-determined contractual relationships. The BFH concluded that the pension fund could not exercise any rights and was only involved and compensated for providing formal access to the treaty benefits. The BFH held that these considerations relate directly to the question of beneficial ownership and not to anti-abuse provision under domestic law or the treaty (which could, however, be applicable following an assessment of beneficial ownership).
In relation to the WHT criterion, the BFH included only a few selected remarks. The mere payment of a net amount or the statement by a foreign bank that WHT had been withheld did not suffice to demonstrate its actual payment.
First observations: Multiple refunds and short sales did not even matter
My initial observations on the decision would be as follows:
- Cum/ex refund claims failed because there was an "overall arrangement of pre-determined contractual relationships" and the refund applicant was merely used and compensated for its tax exempt status, even though it remains unclear what exactly constitutes an overall arrangement of contractual relationships that would remove the beneficial ownership.
- It was not relevant for the tax (but may be for the criminal) law assessment in the case at hand whether the seller of the long future was short, a foreign depository bank was involved, multiple refunds were made or the trade was even cum/ex. Since the description of the overall arrangement referred to the utilization of the tax status of the buyer, this may include other tax-driven transaction structures such as cum/cum but should exclude regular hedging transaction.
- The BFH also did not elaborate on subjective elements such as intent or wilful negligence which may be more relevant for institutions being held secondarily liable. However, it stated in the decision vaguely (and in the press release very clearly) that an earlier decision from 1999 was, as a matter of fact, widely interpreted in a way that an acquirer on the stock exchange could become the beneficial owner before the trade was settled.