23 Jan /19


Cum-Ex – Word of the day – EVS Translations
Cum-Ex – Word of the day – EVS Translations

According to one of American statesman, inventor, and avid writer Benjamin Franklin’s most quotable saying, only death and taxes are certain. And while we can’t do much about one of those, there are certainly ways of getting around the other, yet there’s a great difference between the legitimate and praise-worthy tax avoidance (i.e. legally not paying taxes) and the highly frowned upon tax evasion (i.e. illegally not paying taxes).

And this brings us to one of the biggest stories of the last several years when it comes to investing and taxes: cum-ex trades. While it’s easy to read multiple articles that define this as casual tax evasion; before moving on to the next story, it’s important to understand what cum-ex really means and why it may not be technically illegal.

First, let’s examine the term itself. In this application, cum-ex is a shortened form of cum-ex dividend, with dividend referring to the payment made by companies to their shareholders. As for the ‘cum-ex’ part – surprisingly, for investment terminology – this comes from the Latin words for ‘with’ and ‘without’. Outside of investment jargon, these were first used in English in a work by Robert Giffen entitled Stock Exchange Securities in 1877, which mentions that: “The price quickly rising from 125 cum div. early in July, to 136 ex div. in September.” Without delving too deep into specifics, cum-dividend (‘with dividend’) refers to a stock where the investor is entitled to a dividend that has been declared, and ex-dividend (‘without dividend’) refers to a stock where the investor holds the stock (typically immediately) after the cutoff date for the dividend that has been declared, meaning they’re not entitled to it.

If cum-dividend and ex-dividend are diametrically opposite of each other, what is cum-ex? Simply put, cum-ex is a precisely timed illusion. For Germany and neighbouring countries between 2001 and 2011 (when the loophole was closed), this illusion has been costly in terms of accurately collecting taxes, resulting in a difference of at least EUR 55 billion.

Essentially, here’s how it works between 2 investors, A and B. On or just before the date of record for issuing a dividend, investor A, who owns the shares, loans or sells them to investor B in a way to make the transaction cost neutral. Due to the time needed for a third-party clearing house to fully process the trade and a loophole in German tax law, both investor A and investor B would be shown on the dividend date as having ownership of the shares, meaning that both received tax certificates allowing them to claim a refund on the taxes that the company paid on the dividend. In other words, in instances of cum-ex usage, at least double the tax credits were distributed.

Though this loophole was closed for German residents in 2007, it remained open for foreign investors until 2012, with some tax authorities paying out credits even for several years after that.

Needless to say, the German government, realizing that its own policies and loopholes have allowed for the loss of billions of euros in tax collecting, is not happy; therefore, German authorities, arguing that this was unethical tax evasion (not legal avoidance via a loophole), have been trying to obtain their “pound of flesh” (aka back taxes) through any means necessary. And “any means necessary” means taking the extraordinary step of looking through 10 years of records – through profits already considered secured and closed – and possibly seeking financial recourse. If this wasn’t atypical enough, the investigation has implicated approximately 100 German and international banks, all of the major German banks, and many important individuals in the European banking sector, promoting financial instability.