Cum-ex and cum-cum: how the dividend trades worked and what applies today

In depth11 min read · 13 sources

Cum-ex and cum-cum are the names for share trades around the dividend date that were not about the share but about the German withholding tax on dividends (Kapitalertragsteuer). In cum-ex, participants had a tax that had been paid only once certified and refunded several times. In 2021, Germany's Federal Court of Justice (Bundesgerichtshof, BGH) confirmed that this is criminal tax evasion. Cum-cum trades moved shares of foreign owners across the dividend date to German residents who could credit the tax; since 2016, Section 36a EStG (Income Tax Act) has restricted this. Here you will learn how it worked with simplified worked examples, along with the changes in the law and the case law. This is not a guide and not tax or legal advice.

The basics: dividend, dividend date, withholding tax

When the annual general meeting resolves to pay a dividend, the share trades without entitlement to this dividend from the ex-dividend date; the price then falls by roughly the amount of the dividend. “Cum” means with, “ex” without the dividend. On German dividends, the paying agent withholds withholding tax (Kapitalertragsteuer) of 25% plus the solidarity surcharge, 26.375% in total. Anyone entitled to a credit or refund needs a tax certificate for it. This applies, for example, to a bank that offsets the tax against its own tax, or to a foreign investor who gets part of it refunded under a double taxation agreement.

For private investors in Germany, the deduction generally settles the tax in full (see flat-rate withholding tax (Abgeltungsteuer) and partial exemption). The trades below were therefore conducted through banks, funds and other investors entitled to a credit or refund.

Cum-ex: one tax, two certificates

In cum-ex, someone sold shares with the dividend shortly before the dividend date that they did not yet own. This was a short sale. Delivery only took place after the dividend date, i.e. of a share without the dividend. For the missing dividend, the seller paid the buyer a compensation payment equal to the net dividend. The real shareholder's bank had withheld the tax once; none was withheld on the compensation payment. Nevertheless, two certificates were issued for the same tax, one for the shareholder and one for the buyer (Spengel 2020). In this way, the participants credited the tax at least twice or had it refunded several times (German Bundestag 2017).

Apart from the refund, the trades had no economic substance. According to the findings of the Federal Court of Justice, the participants deliberately worked together, each with their own role, to have tax paid out that had never been paid over (BGH 2021).

Changes in the law in 2007, 2012 and 2016

• Annual Tax Act (Jahressteuergesetz) 2007: for domestic short sales, the legislator introduced a tax deduction on the compensation payment (Section 20(1) no. 1 sentence 4 EStG, with consequential amendments in Sections 43, 44 and 45a EStG). Foreign banks, however, cannot be obliged to withhold German withholding tax; the rule did not cover short sales through them (Federal Government 2014).
• UCITS IV Implementation Act (OGAW-IV-Umsetzungsgesetz) of 22 June 2011, effective from 2012: for shares held in collective safe custody (Girosammelverwahrung), the dividend goes gross to the central securities depository, and withholding tax is only deducted by the paying agent, the shareholder's custodian bank. This removed the settlement basis for the schemes (Federal Government 2014). According to Spengel (2020), modified forms remained possible even afterwards.
• Section 36a EStG against cum-cum: introduced by the Investment Tax Reform Act (Investmentsteuerreformgesetz) of 19 July 2016, applicable to investment income from 1 January 2016, later amended. Since then, a full credit of withholding tax on dividends has required beneficial (economic) ownership on at least 45 days within the 45 days before and after the due date, bearing at least 70% of the price risk during this time, and no obligation to pass on the dividend wholly or largely. Otherwise, three fifths of the withholding tax cannot be credited. Exempt are investment income of up to €20,000 a year and shares that have been held without interruption for at least one year (§ 36a EStG 2016).

In 2017, the Bundestag's committee of inquiry concluded that cum-ex trades had always been unlawful: market participants had interpreted the laws contrary to their purpose (German Bundestag 2017). According to the Federal Court of Justice, there was no legal loophole that would have permitted them.

Cum-cum: shifting dividends across the border

In cum-cum, the share changes hands twice with the dividend: a foreign owner transfers it to a German bank shortly before the dividend date, by sale or securities lending, and gets it back afterwards. The reason: a foreign investor gets the withholding tax refunded at most down to the rate in their double taxation agreement, usually 15%; the rest is a final burden (see withholding tax). A German bank, by contrast, can credit the tax in full. Spengel (2020) describes this as tax arbitrage between taxpayers with limited and unlimited tax liability: the dividend reaches the foreign owner through the purchase price or the lending fee, and the bank gets the tax refunded.

Case law and investigation

• Federal Court of Justice, judgment of 28 July 2021, case no. 1 StR 519/20: anyone who claims withholding tax that was not withheld commits tax evasion. The legal position was clear at the time of the offence: only tax actually withheld may be credited and paid out; mere short-sale agreements do not establish beneficial ownership. The BGH upheld the judgment of the Bonn Regional Court (Landgericht Bonn) of 18 March 2020, including the confiscation of the proceeds of crime, around €176 million in the case of one bank involved (BGH 2021).
• Federal Fiscal Court (Bundesfinanzhof, BFH), judgment of 2 February 2022, case no. I R 22/20: anyone who acquires shares only as a “transaction vehicle” within a pre-designed overall scheme does not become the beneficial owner. A refund requires that the tax was actually withheld and paid over; crediting the same tax more than once is ruled out (BFH 2022).
• Committee of inquiry: the Bundestag set up a committee of inquiry in February 2016; its report, printed paper (Drucksache) 18/12700, was submitted on 20 June 2017 (German Bundestag 2017).
• Tax authorities on cum-cum: the BMF (Federal Ministry of Finance) circular of 9 July 2021 governs the tax treatment of cum-cum transactions in all cases that are still open and replaces the circular of 17 July 2017 (BMF 2021).
• Statute of limitations: for particularly serious cases of tax evasion, the limitation period for prosecution is 15 years (§ 376 AO 1976). Under Section 73e(1) sentence 2 StGB (Criminal Code) as amended by the Annual Tax Act 2020, proceeds of crime can be confiscated even after the limitation period has expired (BGH 2021).

How large was the loss? There are no reliable figures, only estimates that vary widely. In 2017, the committee of inquiry assumed around one billion euros but considered it impossible to estimate the order of magnitude reliably (German Bundestag 2017); according to the evidence it took, the frequently cited €12 billion could be neither confirmed nor refuted (Bundestag Research Services 2019). The tax economist Christoph Spengel put the cum-ex loss for the years 2005 to 2011 at a minimum of €7.2 billion (Bundestag Research Services 2019) and the cum-cum loss for 2001 to 2016 at €49.2 billion to around €82 billion depending on the tax rate, assuming that all foreign owners used such trades (Spengel 2020). According to its own statement, the federal government had no information that would allow the scale of cum-cum to be estimated (Bundestag Research Services 2019).

What the research shows

The ex-dividend date reveals tax rates. Elton and Gruber (1970) inferred shareholders' marginal tax rates from the price drop on the ex-dividend date; differences between investor groups form tax clienteles. Kalay (1982) showed that marginal tax rates cannot be derived from this without additional information; the positive relationship between the price drop and the dividend yield nevertheless remained consistent with a tax effect.

Cum-cum is old. McDonald (2001) studied Germany's former imputation system, in which a tax credit made German dividends worth 42.86% more to taxable German residents than to tax-exempt or foreign investors. On the ex-dividend date, the price fell by more than the dividend plus half the credit, and futures and options priced in more than half of it. This is consistent with costly cross-border tax arbitrage in which foreign investors passed the dividend on to German shareholders.

Cum-ex requires collusion. In a model of the stock market, Buettner et al. (2020) show that cum-ex trades are profitable for buyer and seller at the same time only with collusive tax fraud. In market data for German shares from 2009 to 2015, the number of transactions in suitable shares rose shortly before the ex-dividend dates as long as the refund procedure had not been reformed; they found no effects on prices.

Advanced: the ex-dividend price drop and beneficial ownership

Price drop: if t_d is the marginal investor's tax rate on dividends and t_g the rate on capital gains, that investor is indifferent between selling before and after the ex-dividend date if (Elton and Gruber 1970):

If everyone pays the same rate on dividends and capital gains, the price falls by exactly the dividend. If one group can credit the dividend tax and another cannot, the same dividend is worth different amounts to the two. That is the stuff cum-cum is made of.

Beneficial ownership: for tax purposes, what counts is who owns the share economically (Section 39 AO, Fiscal Code), not just who is its formal owner. Both cases revolve around this: in cum-ex, the BGH and BFH deny it for short-sale agreements and pre-designed overall schemes. In cum-cum, Section 36a, with its holding period, price risk and obligation to pass on the dividend, asks precisely whether the German resident really holds the share economically.

For private investors: buying shortly before the ex-dividend date and selling afterwards brings no tax advantage. The dividend is taxed, and the price drop is a loss that can only be offset against gains on shares (stock loss pot).

Limitations, misconceptions and common mistakes

• “It was a legal loophole”: the BGH rejected this. Only tax that had actually been withheld could ever be credited.
• Confusing cum-ex and cum-cum: cum-ex creates a refund without a tax payment. Cum-cum exploits different crediting rights for a tax that was actually paid; for cases before 2016, the BMF circular applies, and Section 36a only from 2016.
• Estimates taken as facts: the loss figures are based on very different assumptions and are not exact numbers.
• Not a guide, not advice: the examples are heavily simplified and describe completed events. In individual cases, the law, the case law and the tax authorities' guidance apply.

How Portfolio Lab calculates

Portfolio Lab does not model cum-ex or cum-cum trades. The tax module in the Backtest calculates for private investors with a brokerage account in Germany: flat-rate withholding tax (Abgeltungsteuer) of 25% plus the solidarity surcharge, church tax if selected, plus the saver's allowance (Sparer-Pauschbetrag), partial exemption (Teilfreistellung) and Vorabpauschale (advance lump-sum taxation). If you choose, it also taxes the dividends of individual stocks: the gross dividend counts towards the general loss offset pot on the ex-dividend date, and foreign withholding tax is deducted according to the country of domicile and credited at most up to the creditable rate and 25% per income item. German dividends carry no source-country withholding tax, only the flat-rate tax. The app treats funds as accumulating funds (see accumulating or distributing). More in the tax methodology.

This article explains a method; it is not investment or tax advice. Worked examples are simplified and rounded. All terms in the glossary.