The City of London looks after itself
Some of the city of London’s biggest banks are behind a huge tax avoidance trade ‘cheating’ European countries of hundreds of millions of euros a year in a development that sheds fresh light on David Cameron’s decision to wield Britain’s EU veto to protect the Square Mile.
A two-month study by the Bureau has uncovered a discreet $102bn market in European shares whose ‘central’ purpose is tax avoidance. The Bureau’s analysis suggests the European tax loss – mainly to France, Germany and Italy – is up to €595m a year. The scale of tax avoidance will fuel further anger within the EU towards the Square Mile, where the vast majority of the trade known as dividend arbitrage is conducted.
It also served as a stark reminder to George Osborne that British banks are engaged in risky activities as the chancellor yesterday formally responded to Sir John Vickers’ Independent Commission on Banking whose report recommended ringfencing banks’ high street businesses from their ‘casino’ investment banking arms.
Dividend arbitrage is complex. But at its heart, a bank or hedge fund lends equities in often high yielding French, German or Italian companies to another institution. The receiving institution then passes the equities through a network of low or no tax jurisdictions before returning the equities to the original owner using a subsidiary in another tax haven. In this way, banks can avoid the 15% average withholding tax levied on dividends in European countries.
For hedge funds based in the Cayman Islands or Bermuda, the trade is particularly useful in slashing tax bills.
Credit Suisse, the giant Swiss financial services institution, is among a host of international banks and hedge funds involved. The Bureau has seen a Credit Suisse document that details how to implement dividend arbitrage strategies and has received confirmation from a senior derivative executive that the bank was an active participant. When asked whether Credit Suisse engaged in aggressive tax avoidance, the bank declined to comment.
The players?
Among other banks said by City sources to be major dividend arbitrage players are Barclays Capital, Bank of America and Morgan Stanley. All declined to comment.
This looks like a highly artificial operation by London investment banks to cheat German and French taxpayers. Lord Oakeshott, Liberal Democrat
Josh Galper, managing principal of Finadium, a US-based securities lending consultancy and an expert in this area of finance, said: ‘The dividend tax element is central to the trade; without it there would be no reason to engage in dividend arbitrage.’
On learning of the Bureau’s findings, the former Liberal Democrat treasury spokesman Lord Oakeshott called for the Financial Services Authority (FSA), the Treasury and the European Commission to launch an investigation to ensure full disclosure of all dividend arbitrage transactions.
‘This looks like a highly artificial operation by London investment banks to cheat German and French taxpayers,’ he said. ‘If these are genuine commercial transactions for clients, why do they have to be washed through an eye-wateringly convoluted string of offshore vehicles? This sort of behaviour poses huge reputational risks for the City.
‘The FSA, Treasury and the European Commission must work closely together to ensure the whole sequence of transactions of this type is fully disclosed to the British, German and French tax authorities. We must stamp out abusive artificial tax dodging transactions together with our European partners, and stop pretending they are out to undermine the City of London as a responsible and preeminent financial centre.’
Markus Meinzer, applied researcher and analyst at the Tax Justice Network, said: ’This issue highlights a structural flaw in our current international financial system. Governments refuse to institute robust transparency and cooperation mechanisms in view of aggressive financial sector lobbying and because of the bizarre, yet largely unchallenged view of alleged benefits flowing from competition between states.’
Icap, the brokerage run by Michael Spencer, the former Conservative Party treasurer and outspoken critic of EU proposals for a financial transaction tax, is the broking firm most used by banks to buy and sell equities for the purpose of dividend washing, as the trade is more commonly known, according to four well-placed City sources the Bureau spoke to.
The company stated: ‘ICAP’s clients do not disclose to ICAP their commercial rationale for the transactions that they execute. ICAP takes its legal, compliance and regulatory responsibilities extremely seriously and performs all obligations that are required of it by the FSA and other regulatory bodies. It is not ICAP’s role to ascertain any of its clients’ tax affairs, which are confidential and a matter for them and their relevant tax authorities.’
‘Close to the wind’
While dividend arbitrage is a completely legal trade, brokers and advisers spoken to by the Bureau opt not to participate in it. One said dividend arbitrage “sails close to the wind” because of its tax avoidance focus.
Dividend arbitrage also creates huge jumps in equity lending volumes in the second quarter of a year when most companies release dividends. According to US-based Risk Management Association, European equities worth $136.9bn were lent in the second quarter of 2011 compared with an average $70.75bn in the three other most recent quarters where data is available.
Finadium, the US financial consultancy, estimates that 75% of the $136.9bn European equities lending total in the second quarter of 2011 is directly linked to dividend arbitrage. This estimation has been peer reviewed. It means in the second quarter when most but not all dividends are released by companies, equity loans attributed to dividend arbitrage totalled $102.68bn. Average dividend yields in 38 French, 28 German and 36 Italian major equities according to data seen by the Bureau is 5.03%. This means $5.164bn is the total European dividend pot. An average 15% withholding tax on the European total dividend pot applicable on financial institutions should raise $774.6m or €595.05m. But placing dividends in low or no tax jurisdictions means there is no guarantee that €595.05m finds its way to the appropriate exchequers. And as a significant amount of European dividends are posted at other times during the year, the Bureau’s €595.05m dividend tax gap figure, which is drawn from just one quarter albeit the biggest, could in fact be significantly higher.
The Dividend Tax Gap Methodology
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December 18th, 2011 at 11:32 am (#)
Brilliant work – so good to know there are journalists like you out there doing this work and shedding light on this sort of stuff. Is it ridiculous to ask why the BBC’s mighty financial journalastic cohort fail time and again to reveal any of this stuff. Why are stories like this not coming through mainstream programmes like Newsnight? Doesn’t Paul Mason know this stuff is going on? Stephanie ‘stephanomics’ Flanders?? What on earth is THAT about? I know your bureau works collaboratively with organisations from time to time but where can we expect this story to surface in the mainstream media?
December 18th, 2011 at 3:16 pm (#)
This is bare assertion without a single solitary fact to support it. It might be true, it might be complete fiction – without facts nobody knows.
(Editor’s note: this post was partly censored for using offensive language).
December 19th, 2011 at 7:02 am (#)
Come on chaps, banks have been doing this in huge size since at least the mid 90′s…get with the beat will you!
December 19th, 2011 at 1:29 pm (#)
This is eye-wateringly bad news… this article needs to be spread for people to understand the amoral abyss we’re looking down into.
This will be a terrible indictment of the City’s reputation. Terrible news for everybody.
Unfettered greed.
Let’s see how the Tories deal with this.
December 20th, 2011 at 9:50 am (#)
What value to society at large does this have? It appears to be a way of making profit for a few with minimal effort. Surely, in that it has no possible value to society at large, it is legalised theft. The few find a clever way of stealing from others and get away with it by arguing that it is not illegal. Or am I wrong? Please do not tell me it may benefit my pension return for it is still effectively theft.
December 20th, 2011 at 12:10 pm (#)
Who cares, as long as it’s making money for the UK, I couldn’t give a f**k!
F**k the Germans, Italians and the French!
December 20th, 2011 at 12:12 pm (#)
Tax avoidance is a legal practice, as any owner of even very small business would want to minise his tax bills. All businesses, big and small, especially those big enough to hire competent accountants/tax advisers have been doing something similar since the start of tax. Why should this be news? In addition, why should there be an ‘eye-watering’ 15% dividend tax for the state anyway? That’s the state tipping its hands into the pocket of small citizens. That’s equally outrageous. And the state never spends wisely, which is simply the nature of bureucratic organisations in the public sector.
December 20th, 2011 at 12:21 pm (#)
Dear All,
I am simple business man who originally trained as a Chartered Accountant and has dealt with the City several times over the years and whilst I do berate sveral actions of City bankers unfortunately this is one where the blame does not lie with them! And it is incredibly NAIVE of anyone to throw the blame at them.
Mr Ellison the report IS correct. The trade has been around for years, all the large banks do this and quite frankly WHY NOT?
The trade has however actually gotten smaller over the past few years as European witholding taxes are FINALLY being harmonised.
The dividend arbitrage is caused by the various differences in tax laws within both the EU states and other coutnries. It is further compounded by the numerous double taxation regimes in place between member states. Anyone with the wherewithall to research it can see for themselves that dividends of a German company are worth more to investors resident in certain other countries.
In a free market economy where EU and World Policitians are useless at co-ordinating anything why should people not be able to take advantage of such disparities between the tax laws in each country.
However what the report does not state is that a German Fund holding a German stock does not suffer such a withholding tax…. hence why should we denegrate our own banks for using other methods to enhance their profitability when they may not be on a totally level playing field.
If the stock of a company is worth more to a fund resident in the UK than to one resident in the BVI as the UK has a double tax treaty with Germany whilst the BVI may not then why should they not be able to purchase that stock so that a bettern return may be made?
For example, put in layman’s terms – if you knew that you could buy a painting in Germany for £1,000 and because it was more popular in the UK (for whatever reason) you could sell it for £1,500 would you not be tempted to do it?
As with the Global Financial Crisis, this is another example of policitians not being able to regulate industries properly and smarter people taking advantage of such dislocations.
The issue boils down to politicians who are too self interested in retaining their positions and paid too little to do their jobs properly and a serious lack of co-ordination between them.
Harmonise and co-ordinate EU and world fiscal regimes and such arbitrage trades wont be possible. Now you may think what a difficult task this may be however….
All the large tax consultants have whole units specialising in such dislocations, how difficult would it be for the EU to pay them a few million and they will in a couple of months close every single loop hole.
The additonal tax revenue would probably be approximately 10% on the £5bn in dividends giving approx £500mn.
In the words of Orlov the Meerkat – SIMPLES
DO NOT HOWEVER POINT THE FINGER AT THE CITY….
Best Regards and Merry Xmas
December 23rd, 2011 at 10:11 am (#)
Is there a market out there? Definitely. Is the securities lending market being used to facilitate it? Not to the extent being suggested by this article. Not even close. Most of these dodgy “trades” are done via swap or listed EFPs. The rise in sec lending activity in Q2 can easily be explained that a lot of participants in lending programs tend to vote and want their shares back, prompting covering of positions. Another reason is banks shifting short positions out of “local” supply of stock loan that requires 100% dividend and over to “foreign” supply which has a lower requirement. Is this arbitrage? No, it just makes business sense.
December 29th, 2011 at 4:14 am (#)
“That’s equally outrageous. And the state never spends wisely, which is simply the nature of bureucratic organisations in the public sector”
Except when waging phony wars of aggression killing hundreds of thousands of people who just happen to live in a country whose resources one of the British company covets… Like Halburton and KBR did in Iraq… How many pounds did that adventure cost…??
But I see your point, the little hardworking people deserve to pay the taxes… well BECAUSE they have no chartered accountants…. And the million dead..?? Oh well bad wicket…!!!