My Panama Lawyer: Germany Becomes Tax Haven for Firms and ...

09/02/2009

By Beat Balzli and Michaela Schiessl

Part 2: 'The State Is Lagging Hopelessly Behind'

Methods like the Malta loophole work in part because of international double taxation agreements, or DTAs. In these agreements, two countries stipulate in which of the two taxes will be assessed, so as to avoid double taxation. Providers of closed investment funds have discovered the benefits of DTAs. They offer investments in British life insurance, Romanian forestry operations and Spanish solar plants. Thanks to DTAs, German investors only pay taxes on their foreign investments in the respective countries.

The finance committee in the German parliament, the Bundestag, is kept informed about all DTAs, but this does little to address the underlying problem. "Under most tax savings models, the state is lagging hopelessly behind," says Axel Troost, a financial expert with Germany's Left Party.

One of the biggest tax scandals in postwar history illustrates how expensive it can get when politicians are hoodwinked by the machinations of high finance. The process was known as "EX/CUM trade" in bankers' jargon. The trick was so daring that it even made officials at the Association of German Banks queasy.

On Dec. 20, 2002, the bankers alerted the Finance Ministry about the problem. They described a systemic error in the sale of borrowed shares near the ex-dividend date of German corporations. Because of a blind spot in the market transaction system, the original owners of the shares and the buyers receive a statement on the capital gains tax from the respective custodian banks. This enables both parties to claim a refund on the tax, even though it was only paid once.

Out of Reach

Despite this obvious problem, it took a long time for Berlin to react. For another four years, the proprietary trading departments of German banks and wealthy private customers, in particular, fraudulently obtained additional tax statements and submitted them to the tax authorities so that they could claim tax refunds. The German Finance Ministry did not close the loophole until the fall of 2006. According to the ministry, "the current administration, immediately after coming into office in early 2006, drafted legislation to address the issue, which came into effect at the end of 2006."

But this had only solved the problem at the national level. The bank association's warnings that sales through foreign institutions remained "out of reach" were ignored. As a result, the game went merrily along through foreign banks -- until a fired executive of the US investment bank J.P. Morgan allegedly disclosed the full scope of the tricks to officials in Berlin this spring.

A loss totaling in the billions, which had apparently accumulated over several years, was later mentioned in the Bundestag finance committee. Nevertheless, it took the Finance Ministry until May to issue a directive requiring auditors to certify that submitted tax statements were clean.

'Excessive' Requirements

But can the government even win this constant cat-and-mouse game? How can the tax officials be brought up to speed with the highly specialized tax model wizards?

One method, common in the United States and Britain, is to introduce a reporting requirement for tax savings models. This would give the tax authorities advance notice of potential loopholes and enable them to react immediately. The subject was given favorable attention in the Bundestag's finance committee in 2007. "But then the proposal suddenly disappeared," says Green Party Bundestag member Christine Scheel, the champion of the early warning system. Members of Steinbr?ck's staff justified dropping the proposal by claiming that the reporting requirement contradicted "the goals of reducing bureaucracy."

Tax expert Hanno Berger is extremely pleased with the outcome. He believes that a reporting requirement would be "excessive." In fact, Berger feels that many things are excessive, including Steinbr?ck's primitive method of amending laws retroactively.

He cites the example of foreign family foundations. Steinbr?ck wants to amend a paragraph in the German Foreign Transaction Tax Act so that negative income can no longer be claimed to reduce tax liability -- and he wants to do so retroactively, spanning several decades. Even Franz Wassermeyer, a former judge on the Federal Tax Court, says: "This is a catastrophe. It's scandalous."

The Finance Ministry takes a different view of the issue: "Only if the retroactive application is required only in exceptional cases and is consistent with the rulings of the Federal Constitutional Court will it be included in the draft legislation."

Customized Models

The truth is that the retroactive application of laws eliminates all legal certainty. Besides, by constantly issuing new directives the Finance Ministry is practically playing the role of lawmaker, thereby circumventing the separation of powers. "This is unconstitutional," Berger complains. "When it comes to tax law, we are living in a banana republic," he says, referring to laws that he claims have been put together in dilettantish ways.

Such laws do in fact exist. For instance, the new Paragraph 15b of the Income Tax Act prohibits "tax deferral models" which are based on a ready-made approach. But this provision likely applies only to standardized financial products for small investors. The ultra-rich have models customized to suit their needs and, according to a decision by the tax court in the southwestern state of Baden-W?rttemberg, are not subject to the new paragraph of the law. The Finance Ministry, for its part, argues: "It does not follow from the cited decisions that Paragraph 15b of the Income Tax Act should be inapplicable."

Such inadequacies abound in the complicated German tax system. Only a drastically simplified system without significant deduction options, as Heidelberg tax professor Paul Kirchhof advocates, would truly hurt Berger's industry.

...

Translated from the German by Christopher Sultan

Full text in http://www.spiegel.de/international/business/0,1518,646558-2,00.html

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