Deutsche/cum-ex: double dipping spells double trouble for bankers

Skirting the boundaries of tax rules is a profitable activity for financial institutions — for a while. But you can easily get caught out when the political and legal environment changes. Deutsche Bank’s mistake was to heed the pleas of bonus-hungry bankers and ignore the warnings of its own tax experts.

The bean counters said the German bank could end up breaking the rules if it became involved in the lucrative “cum-ex” trading merry-go-round. An internal investigation has concluded that was exactly what happened afterwards.

The international tax system has more loopholes than a medieval castle. New ones appear even as old ones close. Examples? For many years, British brokers offered “bed and breakfast” services. Clients used these to sell and repurchase portfolios to take artificial advantage of capital gains tax reliefs. Then there was Barclays’ famous structured products unit, which made huge sums from tax-based deals in the noughties. Finally, modern private equity is adept at shunting risk capital on to the tax-deductible debt side of the P&L.

As for “cum-ex”, the jargon refers to a tax and regulatory arbitrage using shares that may either be with or without dividends, as the name implies. Typically, a foreign short seller and a tax-exempt German investment fund exploited legal ambiguities in tax laws. They shared the value of reclaiming withholding tax on the dividends of German corporations.

The problem was that a stolid German long fund with no involvement in the trade had usually reclaimed the tax. Cum-ex trades therefore represented a form of “double dip” — making two claims for tax relief using the same asset.

Deutsche may have facilitated cum-ex trading by lending to investment funds, but without acting as principal. Moreover, this was all a decade or so ago. German prosecutors have been investigating the scandal at a snail’s pace. Current chief executive Christian Sewing was relatively junior at the time. He is trying to instil a more sober culture into the previously risk-hungry investment bank.

Public attitudes towards tax have shifted significantly in the meanwhile. Before the financial crisis, the blurred dividing line was between legal and illegal practices. Since then, that question merely prefaces the even more subjective issue of whether a business is paying an appropriate amount of tax. In this environment, investment bank bosses should have no compunction in vetoing trades intended purely to realise artificial tax gains.