The cum-ex scandal explained: the enforcement net widens

The cum-ex scandal has been making headlines for years. As distinct from the parallel cum-cum dividend frauds, the practice involved the trading of shares for the purpose of claiming multiple refunds of the same withholding tax; and the sums involved are huge. However, what started as an issue in Germany, Denmark, Italy and France, is now spilling over into other jurisdictions, including the UK and US.

The sums involved are eye watering. Denmark alone says it was defrauded by DKK 12.7bn (approximately £1.5bn). It has brought criminal charges against nine individuals. The Danish tax authority (SKAT) has brought a civil claim in the English courts against over 100 defendants on the basis that they fraudulently induced it to make refunds of tax for which they were not entitled. A recent Supreme Court decision held that SKAT’s claims were not inadmissible in the English Courts by virtue of the ‘revenue rule’ (the common law principle that the English courts will not enforce foreign tax laws), and the case is proceeding to a full trial this year.

Recent developments

To further underline the importance of this issue to the Danish authorities, they have also recently secured the extradition from Dubai of Sanjay Shah, a British hedge fund trader, who was the alleged mastermind behind the fraud.

Meanwhile in Germany, a number of people have already been convicted for their involvement in the scheme. These include a former banker from M.M. Warburg who was given a prison sentence of over three years for tax evasion, and Hanno Berger, a former tax inspector turned tax lawyer, who received a prison sentence of eight years and three months. It is reported that the German authorities are still investigating thousands of people, including bankers and lawyers.

The detail

So, what exactly is ‘cum-ex’? There are various different iterations across jurisdictions, but the broad concept is as follows. In the affected European countries withholding tax was levied on the payment of dividends. However, certain investors were entitled to reclaim such withholding tax (typically under a double tax treaty). The scheme sought to exploit the refund system by arbitraging the time lag between executing a share sale and its settlement around dividend record dates (the date for determining who is on the share register and entitled to a dividend).

By way of a very simplified summary, one investor would agree to a short sale of shares (i.e., a sale when it did not own the shares) to another investor immediately before the dividend record date (when the shares were ‘cum dividend’). However, the settlement process meant that the shares would be delivered to the new investor shortly after the dividend record date (when the share was ex-dividend). To fulfil that transfer, the short seller would need to borrow the shares from a third party (who actually owned the shares at the dividend record date), and also pay a further amount to compensate for the dividend that had been paid.