Cum-ex – recent questionable milestones in German legislation and case law

December 2021  |  SPECIAL REPORT: WHITE-COLLAR CRIME

Financier Worldwide Magazine

December 2021 Issue

Cum-ex – a form of securities trading around dividend date designed to receive multiple refunds of dividend withholding tax that had only been paid once – has long been said to be the biggest tax fraud in German or even European history, with Germany allegedly being hit hardest. These statements are mainly based on calculations and estimates by tax experts and journalists, but they have yet to be confirmed by criminal courts.

While German tax and prosecution authorities have officially been investigating cum-ex cases for almost a decade, with reportedly about 1200 individuals currently under investigation, only a handful of cases have been brought to trial and only two of them have been decided by the criminal courts so far.

At first sight, in light of general statutory provisions of limitation, one might think that this backlog should pose a problem to the authorities and courts trying to hold individuals criminally liable and to recover billions of euros for the German treasury mainly from companies, especially banks, worldwide. But far from it. The German legislator and the Federal Constitutional Court came to the rescue several times in recent years with rather questionable legislative and judicial actions to avoid limitation periods lapsing, leaving defence attorneys throughout Germany shaking their heads in disbelief.

Legislation

The legislative actions to be mentioned first in this context concern the statute of limitations for the criminal offence of serious tax evasion. This includes all cases exceeding €50,000 in evaded taxes – meaning practically all German cum-ex cases.

In 2020, the German legislator gradually extended the maximum statutory limitation period for serious tax evasion from 25 years to 30 years in a first step and, when that did not seem to be enough, to 42.5 years in a second step. This was explicitly meant to give authorities more time to solve cum-ex cases. Even politicians criticised this second step for being unreasonable and seemingly aimed at compensating for a lack of staff at criminal prosecution authorities.

One has to remember that 25 years was already a long time compared to the maximum statutory limitation period of 15 years for other typical white-collar offences, such as fraud, breach of trust or corruption. The 42.5 years cap now in place is longer than the maximum statutory limitation period for voluntary manslaughter, which is 40 years. It is more than half a lifetime for many people. As one defence attorney recently pointed out in a leading German newspaper: prosecutors, judges and attorneys who are not even born yet may have the chance to work on cum-ex cases.

Particularly relevant for companies are further legislative actions concerning the possibility of confiscating proceeds gained through tax evasion offences.

The Federal Court of Justice decided in 2019 that, based on the clear wording of applicable statutory provisions at the time, confiscation of proceeds was excluded where the underlying reclaim by the tax authorities was already time-barred under tax law. This meant that if the tax authorities failed to reclaim an unlawfully refunded tax amount from the recipient within the statutory limitation period for tax reclaims, it could also not be recovered by way of confiscation. Sounds logical? Not if you ask the German legislator.

In 2020, the applicable statutory provisions were gradually changed, again against the background of cum-ex cases. In a first step, provisions were introduced that explicitly allowed confiscation even if the underlying tax reclaim was time-barred, except for cases where the tax reclaim was time-barred prior to the new provisions coming into effect on 1 July 2020.

Apparently, the legislator felt that without this exception the new provisions would violate one of the fundamental principles of German law – the general prohibition of retroactive legislation. However, that feeling obviously did not last long. A few months later, in December 2020, the exception was rescinded, and another set of provisions came into effect, now allowing confiscation retroactively regardless of when the underlying tax reclaim became time-barred.

Defence attorneys throughout Germany were amazed, if not shocked. They eased their minds by putting their trust in the Federal Constitutional Court because clearly, such retroactive application of the new confiscation provisions had to be unconstitutional. They could not have been more wrong.

Case law

In 2019, the Federal Court of Justice presented a comparable case to the Federal Constitutional Court in which it had to decide on a confiscation of proceeds gained through a criminal offence which had already been time-barred under criminal law when the relevant confiscation provisions came into effect.

The Federal Court of Justice, the highest criminal court in the country, stated in its well-reasoned order referring the case to the Federal Constitutional Court that it was convinced that a retroactive application of these provisions was not compatible with the German constitution, particularly because it would violate the constitutional principles of legal certainty and protection of confidence.

Much to the surprise of almost everyone, the Federal Constitutional Court disagreed. It decided, in February 2021, that a retroactive application of the relevant provisions was justified by paramount interests of the public good, which took precedence over the constitutional principles of legal certainty and protection of confidence. Criminal offences should not pay off, even if they can no longer be prosecuted, and even if it was not the offender who profited, but a third party.

Although the underlying case had nothing to do with cum-ex, it has been widely understood that the Constitutional Court judges were driven by the thought that, had they decided differently, millions if not billions of euros in tax losses could never be recovered. Indeed, the decision came at a time when the German legislator had just introduced the abovementioned provisions explicitly allowing retroactive confiscation, regardless of when the underlying tax reclaim became time-barred. With its decision, the Federal Constitutional Court practically precluded any future attempts to challenge these provisions for constitutional reasons.

Some say that the Federal Constitutional Court would have been obligated to present the case to the European Court of Justice because European law also follows the principles of legal certainty and protection of confidence, which generally exclude retroactive legislation. However, the Federal Constitutional Court did not even address this topic. It would therefore now be for the Federal Court of Justice to do so. Whether it actually will, remains to be seen.

International comparisons

While cum-ex investigations had originally been initiated by German authorities, other European countries followed suit. For example, Belgium, Denmark and the UK commenced proceedings, criminal or regulatory as well as civil, which are largely still ongoing. In total numbers, the impact in these and other European countries does not seem to be as severe as in Germany, which, according to the most recent calculations and estimates, is said to have lost about €7.2bn (the German Ministry of Finance refers to ‘only’ €5.3bn).

Compared to the respective gross domestic product (GDP) of some countries, however, the picture is different. Denmark, for example, is reportedly trying to recover about €1.7bn, which equals roughly 0.59 percent of its GDP in 2020. Germany’s €7.2bn, in contrast, equals roughly 0.22 percent of its GDP in 2020 (and €5.3bn would bring the percentage down to roughly 0.16 percent).

Despite these figures, no other European country seems to deem it necessary to repeatedly change laws or set aside constitutional principles to ensure that the authorities do not run out of time. On the contrary, the latest information from the UK’s financial regulator, the Financial Conduct Authority (FCA), is that it did not open any new investigations relating to cum-ex in the past two years and recently even closed four of the original 22 cases. In Germany, the Cologne prosecutors’ office alone is reportedly investigating more than 1100 individuals and around 100 companies with no resolution in sight.

Prospect

At least in Germany, cum-ex investigations and related court proceedings may now legally continue for years, if not decades. One could even say they have only just begun. It has been reported that the state of North Rhine-Westphalia is even planning to build a whole new courthouse for future cum-ex proceedings. Therefore, individuals and companies involved increasingly face financial and also reputational risks.

In order to assess their potential risk exposure and defend against accusations by the authorities, companies can and in suitable cases should proactively gather relevant information internally. Should they decide not to do so and wait it out, they might be in for an unpleasant surprise sooner or (much) later. The German authorities are in this for the long haul.

 

Dr Julia Baedorff is a counsel at Clifford Chance. She can be contacted on +49 (0)69 7199 1452 or by email: julia.baedorff@cliffordchance.com.

© Financier Worldwide

BY

Dr Julia Baedorff

Clifford Chance

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