On March the 28, 2023, in Paris, the offices of five major banks – BNP Paribas, Société Générale, Natixis, HSBC and Exane (a subsidiary of BNP Paribas)- - were raided as part of preliminary investigations opened in 2021 for suspected tax fraud and tax laundering. These investigations, ordered by the National Financial Prosecutor’s Office (Parquet National Financier), target dividend arbitrage practices widely used by banks: “CumCum” and “CumEx”.
Dividend arbitrage: what is it?
Dividend arbitrage is a common tax optimisation technique that benefits foreign shareholders. Just before the dividend payment period, banks temporarily transfer ownership of a client’s shares to another client residing in a low-tax jurisdiction. The bank and the client then share tax savings from the transaction. In France, tax authorities withhold up to 30% tax on dividends paid by companies to foreign shareholders, depending on the tax residence of the shareholder. This strategy makes it possible to reduce – or even completely avoid – French taxes on dividends. Taken to the extreme, it may even allow some foreign shareholders to request refund, from French authorities, of taxes that they did not necessarily pay.
A legal but potentially abusive tax-optimisation practice
The CumCum technique makes it possible to avoid all or part of the tax levied by France on dividends paid to foreign shareholders by a French company, through two types of financial arrangements.
Internal: This involves transferring the shares to a French resident – most often a bank – which collects the dividends before paying them to the foreign investor. Indeed, in some specific situations, banks (as companies) benefit from a more advantageous tax regime than individuals.
External: Here, a foreign investor’s shares are transferred to another foreign investor, who could also be a bank, resident in a country with which France has signed a favourable tax treaty.
Both types of arrangements, in which banks play a key role, allow the investor to make tax savings in exchange of a commission paid to the intermediary (the bank) for the service rendered.
While tax optimisation via CumCum does not necessarily violate the law, its abusive use raises ethical issues. Dispositions were taken in France in 2019 qualifying as abuse of law CumCum transactions having a “mainly” and not only “exclusively” fiscal purpose. Furthermore, France has ratified a multilateral convention developed under the aegis of the OECD, allowing the benefits of tax treaties to be denied when one of the main purposes of the financial arrangement is to obtain an undue tax advantage. Carrying out a CumCum transaction with an essentially fiscal objective constitutes, at least since 2019, an “abuse of law” that is subject to sanctions.
CumEx: from potentially abusive to certainly fraudulent
CumEx CumEx allows several foreign shareholders to claim tax refunds from the French tax administration (tax that was either never withheld or withheld only once. CumEx is possible because of the high number of exchanges of shares between different individuals shortly before the payment of dividends, making it complicated, if not almost impossible, for the tax administration to identify the “true” owner of the shares. In 2018, the “CumEx Files” investigation, conducted by an international consortium of journalists (including Le Monde and the German daily Die Zeit), exposed the CumCum and CumEx transactions. According to this investigation, the loss of revenue over 15 years for several European countries (including France and Germany) would amount to 150 billion euros. The damage to the French State amounted to 33.4 billion euros. However, given the complexity and multiplicity of the financial arrangements, particularly using short selling, CumEx remains challenging to prove.
Between tax optimisation and outright fraud
While the practice of CumCum is apparently legal, it can be considered borderline from an ethical point of view. Banks defend their use of CumCum transactions by arguing that they strictly comply with the tax rules in force. For Etienne Barel, deputy director general of the French Banking Federation, share lending also meets a real economic need for company financing or financial markets’ fluidity – imposing overly strict rules on French banks would weaken them in the face of their foreign competitors, thus deteriorating the competitiveness of the Paris marketplace.
While we can imagine that dividend arbitrage done ethically could benefit the French economy by allowing quick and easy access to resources and maintaining a certain competitiveness, this does not seem to constitute its main motivation. In this context, the question becomes how to distinguish what is legal from what is abusive, especially when a financial arrangement is mobilised throughout the year, and more particularly in the periods preceding the dividend payments. Does the government really have the means to distinguish between sales for tax purposes and others? And even if this mechanism is recognised as legal, is it ethical?
Our research shows that compliance with the rules does not prevent more opportunistic objectives or using the guise of technical compliance to conceal rather different realities.
In the case of CumEx, the ethical issue is more than obvious because the practice is clearly fraudulent – it’s a straightforward swindle of the tax authorities. Here, the issue is more one of control: CumEx is possible because the speed and the complexity of technological tools, and the number of transactions and tax jurisdictions make it very difficult for the tax administration to identify the real owners of shares. How then to prevent or sanction CumEx? Our research shows that the digitisation of trading activities and their increasing complexity have complicated their control and moral condemnation.
While CumEx is illegal and unethical, banks or tax-optimisation firms may still perceive it as commonly accepted. Furthermore, the limited aspect of controls raises questions about political will and the means necessary to limit these transactions. Research establishes that some technological developments may help to reduce the incidence of financial fraud, but others – such as the anonymity offered by some blockchain applications – will reduce the cost and probably increase the profitability and innovation of fraud.