Behind the Schemes: ‘Cum-Ex’ Fraud and International Principles

What is ‘cum-ex’ fraud? 

Cum-ex fraud refers to a rapid series of trade strategies around a company’s dividend record date, designed to both exploit a loophole in a country’s tax system connected to dividend payments and to facilitate more than one rebate of tax withheld from payments connected to the same shares. The scheme made use of the sale of borrowed shares just before a company was scheduled to pay dividends to obscure the true owner. 

The Case

A British hedge fund trader, Sanjay Shah, founded the firm ‘Solo Capital Limited’ in London, which employed more than 100 financial experts across offices in London and Dubai. Shah recently lost a final bid to block Denmark’s tax authority from pursuing him and others in London over an alleged £1.44 billion-pound cum-ex fraud. Despite Mr Shah’s attempts to block the case from being heard in England, the country’s highest court recently ruled the case can proceed.  

The Danish Customs and Tax Administration (SKAT) issued claims in the Commercial Courts of England and Wales against several parties. In its claims, SKAT alleges that the appellants committed cum-ex fraud by submitting fraudulent applications for tax refunds to which they were never entitled. SKAT was induced to make payments to a value of approximately £1.44 billion, as a result of the fraudulent applications.  

International principles  

The appellants defended the claim on the basis they were protected by a principle of private international law, known as the ‘revenue rule’. The revenue rule is a well-established principle that essentially prevents one country’s courts from enforcing the tax claims of another jurisdiction. The principle is based on the idea that a country’s tax law and revenue collection are considered sovereign matters and should be determined and enforced within the jurisdiction of that country.  

The Commercial Court first considered the ‘revenue rule’ as a preliminary issue and in April 2021, it held that SKAT’s claim fell within the scope of the rule and was therefore inadmissible. SKAT brought an appeal and in February 2022, the Court of Appeal reversed the Commercial Court’s decision and held that SKAT’s claims did not fall within the scope of the revenue rule. Their reasoning for this was that the money sought by SKAT was not owed taxes or any form of taxation; instead, they were funds that SKAT claimed had been unlawfully obtained through fraud. The appellant appealed this decision to the Supreme Court.  

In addition, the appellants argued that SKAT was barred from bringing a claim by the ‘sovereign authority rule’, which prohibits the enforcement of a public law of a foreign state, whether directly or indirectly. The Supreme Court also considered this.   

The Supreme Court Judgment 

Last week, arguments by the appellants that the case amounted to a foreign state attempting to enforce its domestic tax laws in English courts and breached the ‘revenue rule’ were unanimously rejected by the Supreme Courts. The Supreme Court agreed with SKAT that the revenue rule only applies to proceedings where there is an unsatisfied demand for tax, which the foreign tax authority seeks to recover directly or indirectly. The appellants have never been liable to pay any tax in Denmark and the substance of SKAT’s claims is that the appellants have defrauded SKAT and SKAT’s claim has been brought as a victim of fraud.  

The Supreme Court also rejected the argument about the sovereign authority rule on the basis that, whilst Denmark has exercised sovereign power in creating and operating its tax system, this merely provides the context for the present claim. The Court held that the substance of the claims does not consist of any sovereign character, exercise or enforcement of sovereign right or any vindication of sovereign power. 

The London ruling gave the green light for a year-long civil trial starting next April, while Denmark kicked off its first criminal cum-ex trial. The ruling was a blow to Shah, who is being separately criminally charged by Danish authorities. 

What makes this significant?

The wider cum-ex scandals have been estimated to cost European countries €150 billion in tax loss, with the figure continuing to grow year on year. The failure of companies to manage the risk of being used to facilitate such fraudulent trading and money laundering has serious consequences, which has been highlighted by the FCA. The FCA recently fined Bastion Capital Limited (in liquidation) £2.45 million for serious financial crime control failings in relation to cum-ex trading. Bastion ignored or failed to notice several red flags in relation to ‘cum-ex’ trades and should have considered financial crime risks when onboarding Solo clients and when executing the trading.

Businesses operating in this sector should avoid repeating the mistakes of Bastion Capital to avert costly legal and reputational damage and seek to enhance their detection capabilities of fraudulent trading. If suspected misconduct is uncovered, the FCA expects that such firms should be open and co-operative, disclosing to the FCA anything which it would reasonably expect notice of. The balance sheets of individual European banks and other financial institutions are at risk of criminal, regulatory, tax and civil-litigation related consequences emerging from ongoing European investigations. 

International disputes and ‘cum-ex’ fraud cases particularly, encompass specialised knowledge of legal frameworks and jurisdiction complexities. Businesses should consider these potential legal pitfalls and seek advice when navigating claims, country regimes and long-standing international principles, which are not as straightforward as they seem.  

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