Did HOOPP Exploit the Danish Tax System?

Zach Dubinsky of CBC News reports that Ontario health-care workers' pension has up to $430M at stake in Danish tax dispute:
One of Canada's largest pension funds has been hauled into court in Denmark in a dispute about whether it improperly claimed hundreds of millions of dollars in tax rebates on Danish stock dividends, in a country already roiling from an alleged $2.5-billion stock dividend fraud.

Denmark says the case against the Healthcare of Ontario Pension Plan, or HOOPP, involves no allegations of fraud, but instead turns on whether the pension fund truly owned billions of dollars of shares in Danish companies or just temporarily borrowed the stock and collected dividends on it.

At stake is $180 million that was paid out to the pension fund in the form of tax rebates between 2011 and 2014, plus another $252 million in rebates HOOPP claimed since then that the Danish Tax Agency refused to reimburse.

HOOPP — the eighth biggest pension fund in Canada and one of the Top 30 in the world, according to one rankingsays it has done nothing wrong and always "followed the laws" and the terms of the Denmark-Canada tax treaty. It would not comment further, citing the ongoing court case.

The pension fund has total assets of more than $79 billion, according to its latest annual statement, and has 350,000 members working for public- and private-sector health employers in Ontario, including nurses and staff at dozens of hospitals and community clinics.

Possible 'exploitation of the tax system'

The case pitting Denmark against HOOPP hangs on one of the "miscellaneous rules" tucked into the closing paragraphs of the Canada-Denmark tax treaty.

Under Danish law, ordinary foreign investors have to pay a withholding tax on any dividends they receive on Danish stocks amounting to 27 per cent. But under the Canada-Denmark tax treaty, pension funds are exempt provided they are "the beneficial owner of the shares on which the dividends are paid" and they own the shares "as an investment."

The Danish Tax Agency alleges HOOPP didn't meet those criteria.

And while it may seem like a stale quibble over the arcana of tax law, the matter has generated media attention in Denmark.

On Sunday, the Danish public broadcaster DR and the financial daily Borsen both published investigations into the case. They reported that HOOPP held some of the shares in question for mere days — just enough time to collect the dividends — and entered into "swap" contracts to return the stocks to their original owners without risk of losses or gains from changes in the stock price. The reports said it was part of an arrangement with a number of big global banks that set up the stock loans and shared in the profits of the transactions.

CBC was unable to independently verify those findings.

HOOPP has always denied any wrongdoing. In its statement in response to questions about its transactions, it said it "followed the laws and processes of the Denmark-Canada tax treaty, and should be entitled to recover the dividend tax refund. Because the dispute is before the tax tribunal and court, it would not be appropriate for us to make any further comment."

Jan Pedersen, a professor of tax law at Aarhus University in Denmark, told DR in a Danish-language interview commenting on its findings: "Since this is one big circular transaction, it is clear that the participants have tried to make it appear as if one had the formal ownership, and thus the claim to have the dividend tax refunded, even if another, from a strict legal point of view, is the real and beneficial owner.

"It must be regarded as an exploitation of the tax system," he said.

A number of HOOPP members expressed surprise to CBC News that their pension fund is embroiled in the Danish litigation. HOOPP is widely respected in the pension world for generating strong returns while adhering to socially responsible principles such as not investing in tobacco or firearms companies.

Pension fund says it's entitled to refunds

While HOOPP wouldn't answer questions about its dealings in Danish stocks, its financial statements hint at significant transactions in the Scandinavian country. They show the pension fund had a sizeable negative position — the equivalent of $287 million Cdn — in the Danish currency, the kroner, in 2017 that was almost entirely wound up by the following year. It was more exposure than in any other foreign currency except the U.S. dollar, the Japanese yen and the euro.

Last year, when HOOPP's name first emerged in Denmark in relation to the dividend tax matter, the pension fund said in a statement: "HOOPP has been an investor in the Danish capital markets for a number of years, purchasing Danish listed company shares through Danish licensed brokerages.

"As the purchaser of the Danish company shares it has bought, and having received the dividend net of the Danish tax, HOOPP, as a tax-exempt entity under the Canada-Denmark tax treaty, should be entitled to a refund of withholding tax on the dividends received on those shares...

"HOOPP has been working co-operatively with the [Danish tax authority] and, while HOOPP maintains it has not done anything illegal, we understand why the Danish Tax Authority had denied HOOPP's application for dividend tax refunds and had raised concerns about the refunds previously paid. We intend to resolve this issue in the best interests of our organization and our members."

Michael Hurley, president of the Ontario Council of Hospital Unions, which represents thousands of workers who are HOOPP members, told CBC News that his union is aware of the Danish tax case but is confident that their pension fund would only have made the investments if it thought they were "credible and valid."

"This is not a pension plan that's making investments without thought to legality or its social obligations. If it has made a mistake, it will own up to that and repay whatever is owing," Hurley said.

Part of bigger scandal in Denmark

Hurley pointed out that the court case pitting HOOPP against the Danish Tax Agency comes in the context of a move years ago by the Danish government to strip its tax regulators of many of their oversight powers and outsource some of their functions to the private sector.

Indeed, the HOOPP-Denmark litigation is a smaller and more innocuous part of a wider scandal involving the Danish Tax Agency. Following funding cuts, the agency farmed out some of the responsibility for processing dividend tax rebate applications in 2001 to three private banks as part of a broader effort to try to streamline and automate tax collection. The arrangement was scotched in 2015 after an internal audit found evidence of possible abuse, and a public inquiry continues to delve into the fallout from the bungled overhaul.

The HOOPP case is a far cry from the most arresting allegations to emerge. In hundreds of other instances, the Danish Tax Agency is alleging civil but also some criminal fraud involving $2.5 billion in dividend tax rebates obtained by small-scale, mostly American pension funds. Those cases are part of a wider European scandal around a practice called "dividend stripping" that has cost national treasuries billions of euros.

Court documents from one of those cases state that three of the small pension funds are from Canada.
Exactly 12 days ago, a Danish reporter called Bjørn Lambek who works at the Danish Broadcasting Corporation (dr.dk) contacted me via email to tell me they are working on this story and are seeing similarities with other stories they did with other reporters from all over the world.

He asked me to comment and I told him the truth: "I was not aware of this tax case against HOOPP in Denmark. All I can tell you is HOOPP is a very well-run organization, just like ATP which is it modeled after to a large extent, and it focuses on managing its assets and liabilities very closely."

I copied several senior managers from HOOPP on my reply and asked them to comment on this case.

Earlier today, after reading the CBC article, I contacted Jim Keohane, HOOPP's smartest guy in the room, to ask him if he has any further comments.

Jim shared this with me: "This is simply a tax dispute. It is important to note that we followed the laws and processes of the Denmark/Canada tax treaty, and it is our view that we are entitled to the dividend tax refund. Because the dispute is before the tax tribunal and court, it would not be appropriate for us to make any further comment."

Obviously this case will be settled in the Danish courts and if HOOPP is right, it will be entitled to keep $180 million that was paid out to the pension fund in the form of tax rebates between 2011 and 2014, and collect another $252 million in rebates HOOPP claimed since then that the Danish Tax Agency refused to reimburse.

Now, being fiercely independent, I will share my own personal views on this matter:
  • Even if this is proved legal, I don't think HOOPP or any other institutional investor should be engaging in this activity. Period. Denmark is right to widen its probe into multi-billion-euro tax fraud from "dividend-stripping". 
  • Now, if HOOPP loses its case, it's important to note that $432 million represents roughly 50 basis points of its total assets -- hardly the end of the world if they are found guilty and have to pay that sum back to the Danish tax authorities.
  • It's also worth noting that HOOPP isn't the only pension fund engaging in this activity. In fact, let me let you in on a dirty little secret, one of the most profitable activities at Canada's big banks is dividend tax arbitrage, a fancy name for a strategy used by big banks to minimize their tax bill (read Big banks vs CRA: The $2.8-billion tax battle that's been decades in the making). Of course, it's legal (for now) but if you ask me, it's just legalized tax avoidance so the big banks can be a lot more profitable while the rest of the Canadian hosers get hosed on taxes (note: dividend stripping or cum-ex trading can be used as a tax avoidance scheme but the tax treatment varies from one country to another).
  • I find it interesting that HOOPP engaged in this activity in Denmark, probably because of its close ties to ATP, Denmark's powerhouse pension fund which recently reported a record 27% gain for the first half of 2019. But Christian Hyldahl, ATP’s former CEO, was linked to the so-called ‘Cum-Ex’ scandal, related to dividend tax speculation by financial institutions and investors in several countries and it ended up costing him his job even though he maintained that the practices were not illegal, and that he thought it was a legitimate business opportunity at the time. 
The bottom line for me is simple, even if something is legal, you need to navigate anything that looks remotely shady very carefully. It's fair to assume that HOOPP's image has been tarnished from these allegations and I don't believe it was worth it, even if the Danish courts side with them.

[Note: Back in 2014, it was PSP Investments that was embroiled in an aggressive tax avoidance scheme in Germany. More in line with dividend tax arbitrage, in 2016, the Washington Post published an article on the Wall Street tactic that costs German taxpayers roughly $1 billion a year.]

Lastly, let me let you in on something else. Back in 1998, right after I graduated with an M.A. in Economics at McGill University, one of my professors/ friend, Tom Naylor, helped me land a six-month contract job at the Special Investigations unit of the Canada Customs and Revenue Agency (CCRA)which is now called the Canada Revenue Agency (CRA).

I moved to Ottawa, it was a bitterly cold winter, but I walked to Vanier every day to work with a team which was working on some of the biggest tax fraud cases in the country.

I was hired by Jeanne Flemming who later became the Director of the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC) to write a report "estimating the size of white collar fraud in Canada."

Of course, being an astute student of Tom Naylor, McGill's combative economist, I knew fully well it was impossible to estimate this with any degree of certainty. Tom knew it too but he told me to take the job and go live in Ottawa for a bit.

I did and while I was never able to estimate the size of Canada's white collar fraud with any degree of certainty, I did get to meet some of the best forensic accountants working at Revenue Canada and saw first-hand piles of multi-million tax fraud cases, often involving well-known Bay Street funds.

I'll never forget one of the guys working there, Ron Moore, when I told him "Jeanne hired me to estimate the size of white collar fraud in the economy," he chuckled and said "good luck with that."

He also told me unlike the United States, where if you cheat on taxes you can go to jail for decades, in Canada, when they went after tax fraudsters, they would end up settling in court to recover a fraction of the amount that was owed to them. It was then I realized how utterly weak our tax system truly is when it comes to going after big tax cheats and why so many tax fraudsters abound here.

Anyway, like I said, Canada's big banks are all in on the action engaging in their very profitable dividend tax arbitrage strategies to minimize their tax bill while the rest of the Canadian hosers keep getting clobbered with taxes. Keep all this in mind as we head into election season.

Below, Euro News discusses an inquiry into one of Europe's biggest money laundering scandals involving Danish lender Danske Bank where billions of euros flowed through its accounts from Russia and ex-Soviet states.

CBS 60 Minutes also reported on the the biggest money-laundering scheme in history involving a reported $230 billion. It's worth keeping this bigger story in mind as we wait to hear whether or not HOOPP is entitled to $432 million from an activity it claims was well within the law.

Update: After reading this comment, a friend sent me this:
Good post Leo. Problem with what HOOPP is doing is that it makes a mockery of Double Taxation Avoidance treaties. The end result will be that the tax advantage clause will be removed from the treaties punishing investors. So, if you have a legitimate transaction, the treaty will not have a clause to deal with it.
I don't know if he's right about this but he brings up a legitimate point, namely, there are consequences to these strategies and often it's long-term institutional and retail investors who get punished when these treaties are exploited by big investors who should know better.

Another friend of mine whose wife is a member of HOOPP echoed similar concerns and shared this with me on the ongoing tax dispute in Denmark:
Canadians don't pay taxes on investments inside registered plans. Canadian pension plans don't pay taxes on income. Did HOOPP benefit from the tax treaty? Absolutely. Did they do anything wrong? The court will decide if they met the criteria. Pension funds have duration risk and should invest to match that, rather than flip for a tax arbitrage. If a hedge fund or an investor did it we would applaud them for taking advantage of inefficiencies but because it is a large Canadian pension fund (we tend to want to hold them to a higher standard) we scrutinize it. The way I see it isn't an investment, it's a tax arbitrage. The larger consequence could be that several tax treaties maybe looked at an changed and thus punish everyone.
I thank my friends for sharing their insights with my readers and agree with them.