Would you like to read – from begin to end – a 18 page pounderous law draft titled “Law for introducing a duty to report cross-border tax structuring”? The members of the German Bundestag apparently didn’t. After all, nothing seemed wrong with a duty to report cum-ex schemes. So the new law, proposed by finance minister Olaf Scholz, passed legislation on December 12, 2019 without much discussion. Only afterwards its real content, hidden on page 15, became public. It caused incredulity and turmoil among traders and investors. This article deals with the new bizarre German ‘trader tax’, and with ways to step around it.
News about a “1000% tax for traders” and even a “tax on losses” spread quickly in January 2020. Hopefully, fake news? This is the relevant section of the new law (Art. 5 § 20 sentence 6 number 4):
“The Income Tax Act as published on October 8, 2009 (Federal Law Gazette I p. 3366, 3862), last amended by Article 1 of the Law of August 4, 2019 (Federal Law Gazette I p. 1122), is changed as follows. The following sentences are inserted after § 20 paragraph 6 sentence 4: Losses from financial assets within the meaning of paragraph 2 sentence 1 number 3 may only be offset in the amount of 10,000 euros with profits within the meaning of paragraph 2 sentence 1 number 3 and with income within the meaning of § 20 paragraph 1 number 11; sentences 2 and 3 apply mutatis mutandis with the proviso that losses that have not been offset each year may only be offset against profits up to the amount of 10,000 euros with profits within the meaning of paragraph 2 sentence 1 number 3 and with income within the meaning of § 20 paragraph 1 number 11. “
Translation: For the income tax, trading losses cannot anymore be offset against trading profits in excess of EUR 10,000 per year.
Bad enough. But surely they mean that an annual loss can only be offset in 10,000 EUR portions against annual profits in subsequent years? That was at least my interpretation. It made a sort of sense, and appeared harmless if you anyway do not plan to have an annual trading loss. But rumors said that they mean to tax not the annual net profit, but the profit of every single trade. Some said it’s even a tax on every favourable price tick of any open position, since this already constitutes a profit. In any case, this would quickly sum up to an insane tax amount – no matter if you win or lose. It’s in fact not a tax on income, but a tax on volatility, portfolio diversification, and hedging. And it was not even clear for which sorts of assets that tax is due. The relevant § 2 sentence 1 number 3 can be applied to options, futures, and bonds, but possibly also to all leveraged assets such as forex, CFDs, ETFs, and stocks. Only the risky and ecologically damaging speculation with cryptocurrencies seems exempt.
The win/loss offset mystery
For getting clarification, I wrote a letter:
Dear Federal Ministry of Finance,
on my blog I would like to inform readers about the current “Law for introducing a duty to report cross-border tax structuring”, in particular about Art 5 § 20 sentence 6 number 4. However, I am not sure that I fully understood the new law. Therefore I kindly ask you to briefly answer my subsequent questions.
1) Which of the following financial products fall under the referred “financial assets”: stocks, currencies (‘Forex’), options, futures, CFDs, savings contracts with a limited term, German treasury bonds?
2) Which tax is due in this scenario: Bob owns EUR 20,000 that he invests in options trading. He buys about 200 options per year. In one winning year, 101 of the transactions ended with a profit of EUR 1000 each, 99 transactions with a loss of EUR 1000 each. The annual result is EUR 2000. The taxable profit is EUR 101,000, for which Bob has to pay a tax of EUR 91,000 x 25% = EUR 22,750 after deducting EUR 10,000 loss. The tax rate in relation to the EUR 2000 profit is 1137.5%. Is the tax calculation correct?
3) Same scenario, but a losing year. 101 transactions ended with a loss of EUR 1000, 99 transactions with a profit of EUR 1000. The annual loss is EUR 2000. The taxable profit is EUR 99,000. After subtracting EUR 10,000, Bob has for his loss a tax liability of EUR 89,000 x 25% = EUR 22,250.
4) Same scenario, but Bob now tries to outwit the new trader tax. He buys a single long-term position for EUR 20,000 at the begin of the year. Due to leverage, the total value of the position has risen by EUR 100,000 by the middle of the year, then dropped again by EUR 100,000 by the end of the year. Bob sells at the end of the year at purchase price. The year ends profit-neutral and Bob intends to pay no tax.
But the finance ministry is not as easily fooled. Since the tax also applies to the value increase in the middle of the year, the taxable profit minus loss deduction is EUR 90,000. Bob gets a tax bill of EUR 90,000 x 25% = EUR 22,500.
5) Same scenario as 2), but for stepping around the new trader tax, Bob now avoids closing positions. Instead he exercises all options, no matter of in the money or not, shortly before expiration. The paid premium is then not a loss, but a purchase fee. Since the broker offsets simultaneous long and short positions automatically, the finance ministry can do nothing about that.
At the end of the year remains a single long position in the underlying with a value of EUR 2,000, which is then sold. The taxable profit amount is EUR 2,000 x 25% = EUR 500.
6) Same scenario as 2), but for stepping around the new trader tax, the broker has now offered a new structured product. Instead of closing positions, they are converted directly into another asset of the client’s choice that does not fall under § 20 sentence 6 number 4 (for instance, a nonleveraged stock). The premium for selling options is also not paid in cash, but in a position of that asset. At the end of the year, a position with a value of EUR 2,000 remains in Bob’s account, which is then sold. The taxable profit amount is EUR 2,000 x 25% = EUR 500.
I would be pleased if you could briefly tell me which of the tax calculations in the 5 scenarios are appropriate. I would also be interested in a brief explanation of the purpose and motivation behind the new law. And I would be very interested in an explanation how Bob in scenarios 2-4 is supposed to pay his taxes, since they exceed all his capital.
Johann Christian Lotter
I was obviously not the only one who asked the ministry about the new law. I got a long formal response with little information content. It did not answer any of my questions, but confirmed that the 1137% tax and the tax on losses in scenarios 2 and 3 is for real. They did not comment on the tick tax of scenario 4.
Even the experts in Scholz’ finance ministry seem mystified about the implementation, motivation, or objective of this new law. It does not stand alone, but is part of a bundle of similar (although slightly less absurd) laws against retail traders and small investors. Their purpose is a mystery. They seem not motivated by populism. Except for the upcoming transaction tax, few know about them. Some say that they were originally intended against tax scams and large-scale speculation, and only designed in a wrong way. But that is of course impossible, since it would imply a remarkable intellectual incapacity of our lawmakers. Maybe Scholz just intended to show a leftist position for his election to party chairman (which failed nevertheless). Or he’s really convinced that people who live from trading are all speculators and capitalist pigs, and must be hit whenever possible. Who knows. A personal confession at this point: I, also, am responsible for the new tax. I have always voted for Olaf Scholz’ party in the past. Often just out of tradition. This was apparently not always a wise decision.
Four ways to fix the tax
The trader tax will be in effect from 2021. It will then be unique in the world. No other country has a tax on volatility or diversification. I think it will not last long: Traders financially ruined by it, like Bob in some of the above examples, will challenge it in court. The Federal Supreme Court might eventually annul it due to unlawful overtaxation or its blatant absurdity. But until that happens, we’ll have to live with it.
Large-scale tax scammers, speculators, and hedge funds can laugh at Scholz’ tax constructs. They just incorporate, preferably offshore, and are exempt. That’s no solution for small private investors. Scenarios 5 and 6 are two possible ways to avoid the trader tax. A third, relatively simple method would be a trading account in a cryptocurrency. As long as the tax is not applied on open positions, converting one financial asset into another should be tax-neutral, since it does not realize any profit. The problem: You never know what bitcoin, or another account base that brokers might offer for outwitting the tax, will be worth next year. And the ministry was unable to precisely describe how the tax will be applied and which assets are affected. So there’s no guarantee that these workarounds do really work. The safe way is staying below the loss limit.
I know that the Zorro platform, on demand of several German users, will get a new indicator, the Scholz Brake. This indicator will be implemented in the next Zorro release. It can be set up at the session start and at the begin of any year, like this:
if(is(INITRUN) || year(0) != year(1)) // any new year
ScholzBrake = 10000; // activate the Scholz Brake
Once set, the ScholzBrake variable will be counted down by all trading losses of all Zorro instances that run on the same PC and have activated it. So the script can always check the distance to the critical EUR 10,000 total loss limit, and decide what to do. If the variable reaches zero, trading is automatically suspended until the end of the year.
This prevents you (mostly) from the effects of the new law. Of course at the price of not trading for the rest of the year. If you live from trading and have hit the Scholz limit early in the year, you got enough time to look for a new job. Maybe as an expert in the finance ministry.