1. How do Cum-Ex deals work?
Cum-Ex transactions enabled investors to reclaim taxes they had not previously paid. The functionality of these transactions, also known as dividend stripping, is described in a simplified example. The figures are chosen completely arbitrarily; exchange rate fluctuations are not taken into account, as are exchange rate hedging transactions, which in practice cushion possible exchange rate risks.
Shareholder A holds shares in company U worth EUR 100,000.00. The first act of the Cum-Ex transaction takes place shortly before the day of dividend payment, also known as the “ex-day”. Ideally, the (gross) dividend is deducted from the stock market price on this day, after all, the shareholders have received the dividend and a buyer who acquires the share one day later does not receive the dividend. The day before the dividend payment is referred to as the “cum day”. The price difference in the idealized case between cum day and ex day is therefore exactly the dividend determined at the Annual General Meeting. We can hold on: Before the dividend payment, the share price with dividend (cum: lat. “with”), after the dividend payment, the dividend is deducted from the share price (lat. ex: from/from, out).
At the latest on the cum day, an investor B buys C shares in the company U from a foreign investor – worth 100,000.00 euros. The foreign investor C does not own any shares in the company U. It is a so-called short sale, i.e. in order to be able to fulfil its delivery obligation to B, investor C must procure the shares for itself. This is not unusual in itself, however, short selling is commonplace.
The ex-day follows: A receives the dividend on his shares in the company U – 4,000.00 euros are distributed to him. However, A will not actually receive the full dividend, but only an amount of 3,000.00 euros. The company retains 25% of the dividend for the state as capital gains tax. However, for the 1,000.00 euros withheld, A receives a certificate with which he may be able to have the capital gains tax refunded. The shares of company U, which A holds in its custody account, are only worth EUR 96,000.00 after the distribution of the dividend (ex-dividend price).
A now sells its shares to the foreign investor C at the current price of EUR 96,000.00. C can thus fulfil its obligation from the short sale to B. The “problem” for B is now that he has paid C 100,000.00 euros, but only receives shares worth 96,000.00 euros (share price without dividend). This results in a compensation payment from C to B of EUR 3,000.00 – the (net) dividend without tax. For the missing EUR 1,000.00, B can have his custodian bank issue a tax certificate with which he – just as A before – can possibly have the tax refunded. Economically, B is exactly the same as A. Unlike A for the dividend distribution, however, B has just not paid any capital gains tax, so that the claim for tax refund against the tax office has no real basis.
The last strike follows: B sells the shares back to the original owner A at the current price of 96,000.00 Euro. For A, everything is back to normal. In turn, it has values of 100,000.00 euros, namely the shares that are currently worth 96,000.00 euros, the dividend payment of 3,000.00 euros and the tax certificate with which it can have the remaining 1,000.00 euros of the dividend refunded by the tax office. However, such a tax certificate, with which the tax office has to reimburse 1,000.00 euros, also has B, although – unlike A – he has never paid taxes.
This “out of nowhere” claim of 1,000.00 euros is now usually divided between the three parties involved, namely investors A, B and C.