Blockchain can prevent cum-ex fraud

Wim Maas

Cum-ex trades have cost the European tax payer over €55 billion since the nineties. Through elaborate schemes big law firms and investment banks manage to trick tax authorities into giving non-deserved tax rebates. A collaboration of news agencies uncovered the fraud in the so-called “cum-ex files” last year. In this posts I show that decentralized ledgers could be a solution.

What is cum-ex fraud?

The way these trades work is that investment shares are traded or otherwise exchanged temporarily around their dividend date to make it look like the share has multiple owners. This way one or more tax authorities could be inclined to give certain tax rebates or tax credit to multiple “owners” of the share. Knowing the legal tax environment the parties involved came up with structures to be exploited on a regular basis and with huge amounts. An insider explained the scandal as “it’s a bit like parents claiming a child benefit for two – or more – children when there is only one child in the family”.

An investigation led by Correctiv, a German independent news agency, involved journalists from 19 countries. They found that the German taxpayer has been hit for over 36 billion euros. Among other affected countries are France, Denmark, The Netherlands and Belgium.

The essence of the problem is not the greed of the individuals exploiting the hiatus that makes this possible, but the fact that it is. If a company or exchange would know the identity of the shareholders per dividend date and share this with the (read: all) tax authorities, said practice would be hopeless. What is needed is a system of registration that allows monitoring by the responsible authorities.

A solution

Since shares can only have one owner at any point in time. A solid registration of ownership and distribution of this information should mitigate the problem. This means that trusted ledgers, centrally kept by exchanges provided to tax authorities at a real-time basis should be enough to prove or disprove ones ownership. It prevents aforementioned issues of double ownership.

However, a central party in charge of registration comes with certain drawbacks. For one, it introduces a central point of failure that could be susceptible to attack or collusion. For instance, the central party could still distribute different information to different tax authorities. Only network-scale co-operation between tax authorities, securities regulators and exchanges can provide outcome.

Decentralized ledgers

Decentralized ledgers let multiple network participants inspect real-time ownership data. What’s more, they can verify whether transactions in the network are signed with the proper ownership signatures. When tax payers or corporations can be linked to those signatures, this can provide full information to the relevant authorities. (Note that this does not mean this information is public.) This way decentralized ledgers can give authorities a tool to monitor share ownership and transactions for tax purposes.

The Australian stock exchange is currently piloting similar blockchain solutions to register share ownership. A more detailed and technical description of blockchain for securities registration can be found in Yermack (2017).

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