Using blockchain to prevent tax avoidance schemes for dividend payments

In the aftermath of the media attention given to the Cum/Ex structures the German government in their 2021 coalition agreement decided to further pursue the prevention of dividend arbitrage transactions, i.e. abusive arrangements in the context of dividend taxation, and to explore the possible use of modern technologies to achieve this objective. Dividend arbitrage transactions are based on the special taxation procedure for capital gains tax. Capital gains tax is initially withheld in a standardised manner at the level of the withholding entity and then, if required, corrected at the level of the taxpayer. This taxation procedure in combination with the complex depository system of the financial market is abused so as to impede the provision of the information required for lawful taxation.

Blockchain technology, which has already found its way into various financial applications, was explicitly mentioned in the coalition agreement as a technology for preventing dividend arbitrage. A blockchain is a decentralised register of chronologically ordered transactions aggregated in blocks that can ensure the availability and immutability of data and the integrity of the system independently of a central party. This study analyses the extent to which these properties can be used to prevent tax avoidance schemes. Furthermore, it takes into account legal, economic, and technical requirements as well as system costs to propose a practically feasible solution.

The primary result of the study is a concept that attempts to address both basic types of tax avoidance schemes: On the one hand, tax schemes with the aim of multiple tax refunds (e.g. cum/ex) are prevented by a token-based solution in which tokens on the blockchain issued by the tax administration and to be redeemed upon tax refund ensure that the amount of refunded tax cannot exceed the amount that was originally paid. On the other hand, additional information on the tokens makes it easier to uncover and trace tax avoidance schemes aimed at misusing tax refund claims or avoiding definitive tax charges (e.g. cum/cum).

By presenting an explicit solution concept the study demonstrates that blockchain technology can already be used to prevent excessive tax refunds. By providing traceable and tamper-proof information the technology also has the potential to create benefits in the fight against other tax avoidance schemes. However, maximising these benefits would require using blockchain technology as base for the entire financial infrastructure, especially for securities book entry, trading, and settlement. While this is considered unrealistic in the short term, current regulatory, technological and social advances may set a path to enable this in the future.

As a result, the study not only shows the current possibilities of blockchain technology to prevent tax avoidance in the form of dividend arbitrage, but also provides an outlook for the future, offering an additional incentive to continue and even intensify efforts to use blockchain technology for the financial infrastructure.

Please access the complete study report here (in German).