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FRIPRO-Fri prosjektstøtte

Redesigning the Dividend Withholding Tax & Closing the Loopholes

Alternative title: Omstruktureringen av kildeskatt på aksjeutbytte & stenge smutthullene

Awarded: NOK 7.7 mill.

Project Number:

300955

Project Period:

2020 - 2025

Funding received from:

Location:

In October 2018 a cooperation between journalists known as CORRECTIV uncovered the largest ever European tax fraud. Investors exploited loopholes in the dividend-withholding tax (DWT) that allowed them to avoid the tax, or even to receive reimbursements that exceed tax payments. Three schemes are at play known as cum-cum, cum-ex and cum-fake. The Cum-Cum scheme allows investors to be reimbursed for DWT payments, when they should not be. The Cum-Ex scheme allows investors to be reimbursed twice, for a tax that is only paid once. The Cum-Fake scheme allows investors to be reimbursed for a tax that was never paid. We refer to these schemes collectively as cum-schemes. The revenue loss in Europe is not yet known, but estimates suggest the damage exceeds 200 billion euros. Despite diligent reporting by journalists, there remain many gaps in our knowledge that can best be answered by academic economists specialized in econometrics and taxation. One of the countries that is severely hit by the cum-schemes is Denmark. Denmark introduced a reform in 2016 targeting at closing all loopholes at once. TAXLOOP has analyzed the consequences of this reform by comparing Denmark to its Nordic neighbors (which have not attempted to close the loopholes so far). Our analysis makes use of the fact that most cum-schemes use the security-lending markets on which stocks are loaned from one party to another. If many investors are engaged in cum-schemes, the number of stocks on loan spike sharply around dividend-payments. Prior to 2016 these spikes are commonplace in all Nordic financial markets. After 2016, the trading pattern disappears in Denmark, but persists in the other Nordics. We also look at broader economic consequences, and find that annual DWT revenue in Denmark increased by approximately 130% or 1.3 billion USD as a result of their reform. These numbers suggest that the cum-schemes have been even more costly to the Danish government, than what was uncovered by journalists in CORRECTIV. Some policymakers fear that closing the loopholes negatively affects the investment climate. We do not find evidence for this in Denmark. TAXLOOP has further analyzed trading patterns in 16 European countries. At the beginning of our sample (2010) we find that the tell-tale sign of cum-scheme trading, sharp spikes in stocks on loan around dividend days, is present in all European financial market. Spikes are largest in Germany where they constitute 10 percent of traded stocks on average. In other countries spikes range between 1-6 percent of traded stocks. Spikes in Germany and Denmark disappear after 2016. This is consistent with interventions by policymakers in both countries in the same year. The trading pattern continues to be present in other European countries until the end of our sample period (2019). TAXLOOP further zooms in on the Germany to better understand which cum-schemes are most relevant. Here, Germany offers an ideal case-study, since they introduced a 2013 reform which only targeted cum-ex trading, and a 2016 reform which targeted cum-cum trading. We find that, at most, 15 percent of cum-scheme trading can be explained by cum-ex, whereas the other 85 percent is explained by cum-cum. Norway has also introduced its own set of documentation requirements in 2019. TAXLOOP has investigated whether this reform was as succesful, as the German and Danish interventions. Unfortunately, using the same methodology as for Germany and Denmark, we do not find that the Norwegian reform had any effect on cum-cum and cum-ex trading. Spikes in stocks on loan remain after the reform. The main difference between the Danish and the Norwegian reform appears to be that Norway does not require shareholders to confirm their beneficial ownership. Since this key requirement is missing from the Norwegian documentation requirements, it follows that the reform was ineffective in halting cum-cum/cum-ex trading. TAXLOOP has also considered the role of dividend taxes in the larger tax system, in particular in the interaction with taxes on wealth. Dividend taxes, on their own provide companies with a large incentive to keep funds in the form, rather than paying out dividends, since postponing the payout of dividends reduces the net present value of tax payments. We show that the wealth tax can eliminate this incentive to postpone. The intuition is straightforward: paying dividend taxes reduces net wealth, which in turn reduces wealth tax payments. Hence, the wealth tax payments provides an incentive to pay out dividends immediately, rather than postponing, thus eliminating the pay-out distortion introduced by the dividend tax. Overall, TAXLOOP finds that both the Danish and the German approaches offer viable paths for governments to strongly reduce trading related to cum-schemes. The result is a substantial increase in tax revenue, with no evidence of negative effects on the investment climate. The Norwegian reform has not had the same success.

In October 2018 a cooperation between European journalists known as CORRECTIV uncovered the largest ever European tax fraud in the cum-ex files. Cum-ex, and related strategies known as cum-cum and cum-fake (henceforth cum-schemes) are schemes that allow investors to avoid paying the dividend-withholding tax (DWT), or to receive excessive tax reimbursements. The revenue loss in Europe is not yet known, but estimates suggest the damage exceeds €100 billion. Despite diligent reporting by journalists, there remain many gaps in our knowledge that can best be answered by academic economists trained in econometrics and optimal taxation. TAXLOOP will collect and analyze a financial and regulatory database for at least 17 European countries that gives an overview of the current state of DWT. We will use the data to find out which countries have been affected by the fraud and how much revenue is lost. TAXLOOP will also provide policy advice on how to design the DWT to make it more robust against tax avoidance. Finally, we will take a step back and reevaluate what role the DWT should play in the overall tax system. The tools we use in our analysis are econometrics, machine learning and optimal taxation. TAXLOOP will contribute to existing knowledge by being the first to provide a European-wide analysis of the impact of the cum-schemes, and by empirically evaluating the regulations that make a country vulnerable to them. We also provide the first optimal DWT-model that will allow policy makers to better design their DWT.

Funding scheme:

FRIPRO-Fri prosjektstøtte

Funding Sources