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posted on 10 May 2016

German Finance Minister Cries Foul Over Tax Avoidance Deals

Special Report from ProPublica

-- this post authored by Cezary Podkul

The German government may not be able to recover billions of dollars in lost dividend taxes from complex stock-lending deals that benefited U.S. and other foreign investors.

Germany's top finance official criticized controversial stock loans that allow U.S. and other foreign investors to avoid paying about $1 billion a year in dividend taxes in Germany.

Finance Minister Wolfgang Schäuble said Wednesday. He strongly suggested that banks discontinue the practice:

""I think we made very clear that we were not happy about these activities. I am sure that all responsible banks and their boards will deal with this topic."

Schäuble's statement came a day after publication of a joint investigation by ProPublica, the Washington Post and the German news outlets ARD and Handelsblatt about the trades, which are arranged by U.S. and other banks using stocks borrowed from investment managers like Vanguard and BlackRock.

One major German player in the transactions - Commerzbank, Germany's second largest bank - has since said it will discontinue such deals even before a proposed law to end them can be adopted.

But the larger question of whether Germany will get back the billions it lost remains unanswered. Schäuble said Germany cannot claw back taxes that were avoided in legal securities lending. Though Schäuble called the trades "not legitimate," experts differ on whether they are forbidden under current law.

Revelation of the bank's participation in div-arb put Schäuble in an awkward spot. The government owns 15 percent of Commerzbank and has two seats on its board thanks to a 2008 bailout. And while taxpayers lose on the stock deals, they make money for Commerzbank's shareholders.

The controversy centers around a trading strategy called "dividend arbitrage," or "div-arb," in which large foreign investors lend out their holdings of German stocks so they are not on their books at dividend time.

The borrower is a German fund or bank that doesn't have to pay the 15 percent dividend tax that applies to foreign investors. After dividend time, the shares get returned. The tax savings are then split among the investors, banks and other players.

Confidential documents obtained by ProPublica identified Commerzbank as a key "end-user," where borrowed shares can be parked temporarily to avoid withholding taxes. They also named a who's who of global banks that enable the transactions and major investment managers that lend out German stocks.

Wall Street Stock Loans Drain $1 Billion a Year From German Taxpayers

Carefully timed deals help big money managers skirt dividend taxes in 20 countries, confidential documents show. Read the story.

How Div-arb Works

Here's how big investors shuffle shares around to avoid paying the tax. Learn more.

Commerzbank's share price dropped nearly 10 percent since news of its involvement and a weak earnings report, and German politicians said they were shocked to learn that the bank helped investors avoid taxes.

One member of parliament called Commerzbank "morally bankrupt." Thomas Schäfer, finance minister for Hessen - home to Frankfurt, Germany's financial capital - called div-arb "pure tax trickery on the back of society" and warned that banks who engage in the practice face "loss of credibility and image" that can outweigh any profits gained from such transactions.

Schäuble is the highest-ranking German official to criticize the transactions. His agency has proposed legislation to stop the trades by making them too risky. A parliamentary hearing is set for next week.

At a news conference Wednesday, Schäuble sought to explain why, under current German law, the government may not be able to recover the tax revenue it has lost from the transactions.

Schäuble said:

"One paragraph in the general tax code says that if you use some tax instruments to avoid tax paying and if there is no economic purpose, then there could be a misuse. Excessive use of these instruments is not legitimate."

But Schäuble added:

"As long as these instruments, according to the highest courts, are and were not illegal until today, I cannot reclaim tax money."

Following is some of the other reaction inside Germany:

  1. Norbert Walter-Borjans, Nordrhein-Westfalen State's finance minister (NRW is Germany's most populous state) who belongs to the center-left Social Democratic Party of Germany

    Walter-Borjans told Handelsblatt:

    "I see no other reason for it (div-arb) other than tax law abuse."

  2. Carsten Schneider, the deputy chairman of the SPD parliamentary group responsible for budget, finance and Euro policy

    Schneider told Handelsblatt:

    "Schäuble must now quickly clarify, why the finance ministry and the financial market stabilization agency have not monitored this."

  3. Ralph Brinkhaus, the deputy chairman of the CDU/CSU parliamentary group for budget and finance.

    "We will very precisely look into the role of Commerzbank and the other German banks," Brinkhaus told Reuters. He considers the transactions not to be legitimate, because they only serve tax minimization.

  4. Gerhard Schick, the finance policy spokesman of Germany's Green Party

    "In Parliament, we will find out how long the federal finance ministry has known of Commerzbank's trades and why Commmerzbank was not hindered from doing them. If necessary, we will ask these questions in an investigation committee."

    Schick's full statement in German is available here.

  5. Bernd Riexinger, chairman of Germany's Left Party

    He said in a statement

    "I doubt that the dividend deals are legal. In no case are they decent. Investment banking is the playground for tax thieves, is not systemically relevant to the financial system and therefore should be liquidated,"

  6. Anton Hofreiter, chairman of the Green Party parliamentary group

    "Assisting in tax avoidance, the committees [overseeing ex-Commerzbank CEO] Martin Blessing have conned citizens out of billions. In this way, they harm those who, with so much money, saved Commerzbank from bankruptcy. The management of Commerzbank, in light of this behavior, is morally bankrupt."

    Hofreiter's full statement in German is available here.

  7. Klaus Nieding of DSW, the German Protective Association for Security Holdings, (representing Commerzbank shareholders)

    Nieding called for the board of directors and managers of Commerzbank to provide a full explanation of its activities. "A blemish on Commerzbank's reputation must not remain," he told ARD's Munich affiliate, Bayerischer Rundfunk.

This article was written by Cezary Podkul, with reporting contributed by Arne Meyer-Fünffinger of Bayerischer Rundfunk in Berlin and staff of the Handelsblatt newspaper. Research and translation contributed by Jennifer Stahl.

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