ISLA has worked with members to ensure a coordinated approach to GITA – firstly to avoid any disruption in German equity markets, while preserving the German lawmaker’s aim of ensuring that dividend arbitrage transactions are prevented. Secondarily, to provide the German Federal Fiscal Ministry with the securities lending industry’s approach to the implementation of GITA, and specifically the provisions introducing taxation of income from securities lending and repos of an Investment Fund referred to as the “Manufactured Dividend Rule”.
The Manufactured Dividend Rule renders the income from securities lending and repos subject to German taxation at the rate of generally 15% in the hands of a lender and repo seller respectively, when such lender or repo seller is an Investment Fund. The purpose of the Rule is to complement the general taxation of German dividends paid to Investment Fund and should prevent any potential for circumventing the taxation on genuine dividends, where Investment Funds engage in securities lending and repo transactions. In ISLA’s opinion the existing anti-cum cum legislation is robust. In particular, the 45 day holding period (the need for outright economic exposure on a substantial part of the long position and the disallowance of tax benefits where there is a contractual obligation to make an onward payment of income received as dividends) all work together to prevent cum-cum trading. Accordingly, even without the new legislation, the residual tax arbitrage risk, if any, should be very low.
Due to a lack of clear understanding across the industry, lenders may determine that the risk of lending securities is no longer low and therefore will withdraw from the market, rather than accept a higher level of risk or uncertainty. A number of members have indicated that they may have to cease securities lending activity in German equities mid-December in order for positions to be fully returned by borrowers before January 1, 2018. It should be noted that a wholesale withdrawal of liquidity over the typically lightly traded Christmas period, could have an unpredictable and outsized impact on equity markets.
In order to ensure that the market can continue to operate from January 1, 2018, ISLA proposes adopting a standardised approach. This is based on the industry’s common understanding to comply with the new Manufactured Dividend Rule and to seek the German Federal Fiscal Ministry’s early guidance if in disagreement with the approach proposed for 4 key aspects such as: In-Scope Transactions, Tax base, Collection of Tax and Application of a Double Tax Treaty (DTT).
ISLA have concentrated on making the Rule, as it is written, workable and therefore they have focused their submission on the time sensitive parts of the Rule which have the greatest potential to disrupt the German equities market.
Getting a concession on lending fees and that borrowers cannot be forced to withhold, along with acknowledgement of the character of Other Income for tax treaty purposes, is the maximum ISLA hope for within the time frame. If their objective is achieved and the tax is limited to the manufactured dividend, then they have bought some additional time to work out the details ahead of the main dividend season in May. However if agreement on these points is not met, ISLA believe the outlook is poor.