A joint media investigation has alleged that major funds are deliberately seeking to avoid paying a dividend withholding tax in Germany by lending out shares to German banks.

Newspapers Handelsblatt and the Washington Post, along with investigative journalism group ProPublica claim to have obtained a “cache of confidential documents” showing “complex stock-lending deals”.

The group claims the trades, known as dividend-arbitrage, or 'div-arb' transactions, are “structured and marketed as tax-avoidance vehicles that drain an estimated $1bn a year from the German treasury”.

Under current German law domestic funds can claim a credit on a 15% withholding tax paid on dividends which foreign funds cannot.

An example of the trades in question, the media group suggests, would be when a money manager briefly lends out some of their German holdings each year.

Those shares are temporarily held by German investment funds and banks that by law pay no tax on German dividends or can claim refunds for tax withheld.

“The banks or funds that borrowed the shares receive the dividends tax-free and then transfer that money to the stocks’ original owner,” the Washington Post article added.

The media report alleges that major institutional investors made use of the loophole, while certain banks had helped.

A spokesman for Germany's finance ministry was quoted by Reuters on Wednesday, saying: "To make it clear: we consider the 'cum-cum’ (dividend stripping) deals illegitimate because their sole purpose is to avoid the legal taxation of dividends."

The spokesman also said that he expected banks to address this issue, according to Reuters, adding however that he could not ask them to repay taxes avoided in the past if the banks concerned had not broken the law.

The German government drafted a law to close the loophole back in February.

Responding to the media report, Vanguard, BlackRock and Fidelity all said their securities lending follows applicable laws and is designed to help investors.

"Vanguard, like many other mutual fund companies, has long engaged in securities lending -- a widely accepted investment activity that Vanguard employs prudently to add value for our clients," said a Vanguard spokesman, speaking to Global Investor/ISF.

"Vanguard follows all applicable regulatory, tax, and legal standards related to securities lending in the markets in which our funds invest."

All three money managers - BlackRock, Fidelity and Vanguard - have always been “completely transparent in their lending activities", an individual from a major bank told Global Investor/ISF. 

“They all lend to generate additional revenues and have been for decades."

“In our program, no client has ever joined to avoid tax, they join to generate extra yield for their shareholders,” the spokesperson added.

ISLA, the securities lending body, has been active when it comes to educating market participants about Germany’s tax rules.

It has also worked closely with the German Ministry of Finance.