Focus on Tax Compliance and Tax-CMS in Germany

"Compliance" is the strategically intended and executed compliance with relevant laws through using a protection and control system intended to provide protection against violations of the law and the consequences resulting from this. When referring to the active compliance with tax obligations of a company and the accompanying avoidance of liability and penalty risks, we generally speak of “tax compliance”.

What is the purpose and objective of a Tax Compliance Management System (Tax CMS) under German law?

An effectively structured tax CMS is designed to raise awareness of structures, work processes and matters within the company which have (or can have) tax implications as well as to monitor and, if required, modify these. This is intended to create framework conditions for a correct “tax conduct” and, concurrently, to develop a sensitivity for matters which are relevant regarding taxation. In this way, resulting tax payments and liability risks are avoided or, at least, reduced.

In connection with monitoring of deadlines, it is, e.g., a suitable tool for supporting compliance with deadlines and, as a result, it contributes to preventing fines for delays (section 152 AO [Tax Code]), late payment fees (section 240 AO) or, in individual cases, arbitrary assessments (section 162 AO). Moreover, the risk of liability cases can also be reduced or eliminated outright. Complicated, controversial or incomplete matters can be recognised and acknowledged in terms of taxation early on and before the submission of the tax return so that, e.g., criminal investigations on grounds of tax evasion (section 370 AO) or non-compliance procedures on grounds of reckless tax reduction (section 378 AO) are avoided. Last, but not least, a working tax CMS will also have positive effects on the type and extent of a tax audit. Through internal control and documentation, the management can concentrate on the actual issues in dispute in the context of the audit.

Is a tax-optimal alignment of a company still possible under German law after the setting up of a tax compliance management system?

The establishment of a tax compliance management system does not mean that companies have to forego tax-payment reduction optimising options. Instead, tax compliance is designed to help attain the aim of reducing the tax burden under consideration of the statutory requirements. In addition, non-compliant behaviour can be avoided. Furthermore, legal opinions deviating from those of the fiscal authority can still be proposed. However, this is subject to the condition that these are shown and disclosed.

Do I need a tax compliance management system?

A tax CMS offers benefits in many respects: It safeguards an organisation so that you can be certain that the structures and processes created adequately address tax-relevant subjects under German tax law. This gives you security. Moreover, a tax CMS offers protection against the accusation of disorganisation within the company (Administrative Offence Act) or even the accusation of premeditated tax evasion ( HYPERLINK "https://www.lhp-rechtsanwaelte.de/steuerstrafrecht/"Criminal tax law). Even though an existing tax CMS under German law can only be seen as an indicator that there was no premeditation or recklessness (cf. section 153 AO), it is, in particular, the tax-honest companies that have an intrinsic interest in a tax CMS since it can help them to document their scrupulousness regarding tax. Therefore, the subject of "tax compliance" is basically relevant for everyone.

Does the use of a tax compliance management system provide advantages when dealing with the tax office in Germany?

A Tax CMS which has been set up and is well-documented is assessed as being positive by the fiscal administration, especially, in the case of tax return corrections. This is because if you are able to develop a holistic tax CMS, you do not only build more trust internally but also with the competent tax office. If an error does appear in the tax returns, a tax CMS can ensure that allegations of premeditation or recklessness in the compilation of an incorrect German tax return can be defended, and it can also help to ensure that a correction of the tax declaration can be effected as a revision rather than a HYPERLINK "https://www.lhp-rechtsanwaelte.de/steuerstrafrecht/selbstanzeige/"self-disclosure. This might help to avoid, e.g., criminal investigations on grounds of tax evasion (art. 370 AO) or non-compliance procedures on grounds of reckless tax reduction (art. 378 AO). However, a working tax CMS might also have positive effects on the type and extent of a tax audit.

How do I design a tax compliance management system?

There are no generally recognised specifications or requirements as to what a tax compliance management system should look like under German law. The respective circumstances of the company need to be taken into account and hence an individual bespoke design is needed. Nonetheless, indications regarding the design can be derived from various sources. For example, according to IDW [Institute of Public Auditors in Germany], a tax compliance system is considered appropriate "if it is suited to both detect risks as to essential violations and to prevent such violations in due time with sufficient security". This means preventative and identifying measures are required. A tax compliance system is considered as being effective if these principles and measures are recognised and observed - in short "implemented" - by the parties concerned in line with their respective responsibility in the ongoing business processes. As a result, continuous monitoring, updating, improvement and training of the parties involved are required.

Is the introduction of a tax compliance management system under German law also possible for specific segments?

A tax CMS for a certain partial business/accounting segment is certainly conceivable. For example, compliance guidelines on value-added tax can be developed. (VAT forms the main risk factor for many companies.) However, such a design is not particularly recommendable. The term "tax" should be interpreted as comprising all taxes and similar charges. Therefore, the tax CMS can also include the fulfilment of archiving, accounting and recording obligations, as well as the rules regarding compliance with deadlines, competences for reviewing tax assessments and objection procedures as well as restructuring measures, cross-border matters and tax audits, in addition to compliance with the obligation to submit tax returns for the various types of taxes and charges. Moreover, this list is not conclusive.

Tax compliance and value-added tax: What are the main aspects of an audit?

Value added tax has proved to be the biggest tax risk field for many companies in Germany in recent years due to (amongst others) the following reasons. It is vulnerable to fraud because of existing system problems. While it is of significant importance as tax revenue, it frequently constitutes a focus of the audit by the fiscal authority.

Therefore, the fiscal authority regularly checks the correctness of invoices, the right to deduct input tax and - in particular regarding cross-border transactions - recording of documents and proper accounting in the field of sales taxes in the framework of HYPERLINK "https://www.lhp-rechtsanwaelte.com/tax-law/field-audit/special-VAT-audit/"Special VAT audits.

In this field, close attention is paid to the question of whether the business partners have convinced themselves of the existence and entrepreneurial status of the respective business partner. Therefore, the sales tax assessment of every performance relationship in terms of its contents requires a high degree of knowledge of tax law and creates demanding requirements for the employees in charge.

For this reason, these aspects would be considered specifically in the sales tax segment in the framework of a tax CMS:

• Do the invoices include the characteristics required under art. 15 UStG [German Sales Tax Act]?
• Are recurring invoices issued correctly?
• Are the performance relationships identical with those detailed in the invoices issued?
• Are sales-tax training and further training measures carried out?
• Are new business relationships reviewed satisfactorily?

Tax Compliance and tax accounting and recording obligations under German law –
Where does it start?

An effective tax compliance management system also comprises the fulfilment of the tax accounting and recording obligations as specified in section 140 et seq. AO. This field of tasks should not be underestimated. Certain taxable persons are obliged to keep books and records. In this context, the principle of complete, correct, timely and ordered accounting applies (section 146 AO). With a letter dated 14/11/2014, the Federal Ministry of Finance published comprehensive amendments regarding the definition of “proper accounting” with effect as of 01/01/2015. This primarily concerns companies which fulfil their accounting, recording and archiving obligations using electronic formats with the help of IT systems. If the comprehensiveness and verifiability of compliance with the procedural provisions in art. 146 AO cannot be satisfactorily established through procedural documentation, the fiscal authority can consider this a defect of material value. This could e.g. result in the risks of an HYPERLINK "https://www.lhp-rechtsanwaelte.de/tax-law/field-audit/arbitrary-assessment-in-company-tax%20audit/"arbitrary assessment of taxation bases according to art. 162 sub-section 2 sentence 2 AO.

How does a tax compliance management system help me in fulfilling my obligation to submit tax returns or in my obligation to cooperate with the tax office?

Every taxable person is required to submit a tax return. This also includes the sales tax and payroll tax return. The German tax laws govern the question of who has to submit which declarations. Furthermore, these returns have to be submitted subject to certain declaration obligations. The compliance system should, e.g., specify and ensure the internal competences regarding the preparation and submission of tax returns, typically, in order to avoid the non-submission or delayed submission. Of course, the concrete deadlines should be clear with regard to the latter. Moreover, a tax compliance management system can also help to avoid the submission of materially incorrect tax returns (principle of dual control).

Generally, every taxpayer is obliged to cooperate with the tax office. This applies, in particular, in international matters and field audits. A tax CMS helps to avoid the violation of the duty to cooperate. In this context, compliance guidelines are created which provide clear documentation in order to avoid conflicts with the fiscal authority.

Tax compliance and cash management - what do you need to know - is your cash management tax compliant?

If cash management is not performed correctly, this can mean that the entire accounting function is no longer considered as being correct. Therefore, the German tax office can assess the taxation bases according to art. 162 section 2 sentence 2 AO. If it is thought likely that the actual conditions are being hidden and taxes are consequently being evaded due to the incorrect records, this will also result in the initiation of HYPERLINK "https://www.lhp-rechtsanwaelte.com/tax-law/criminal-tax-proceedings/"preliminary investigation proceedings regarding suspected fiscal offences.

Therefore, a tax CMS can support you in ensuring compliance with the accounting and recording obligations. Companies with cash receipts usually use cash registers, PC cash register systems or open tills. As part of the accounting process, these systems are subject to the same recording and retention requirements as are complete accounting systems. The fiscal authority differentiates based on the type of cash register system used. This governs the requirements which apply with regard to recording of the data. Generally, the following applies: The data which are recorded and can be provided technically also have to be retained in a reasonable way. In this respect, it should be noted that the law provides for a so-called "individual recording obligation" (see art. 238 HGB [German Commercial Code], art. 140 to 148 AO and art. 22 UStG, i.e. the entire revenue and income has to be recorded individually, in principle) and with a retention period of ten years.

Tax compliance and hidden distribution of profits - what needs to be taken into account?

The topic of hidden distributions of profits regularly arises in limited liability companies [GmbH] and other joint-stock corporations. The German fiscal authority checks, in particular, the performance relationships between the company and its shareholders or close relatives. Risks regarding the assumption of a hidden disclosure of profits arise wherever excessive benefits are granted - as seen from the perspective of the fiscal authority.

The following has to be considered in order to avoid the accusation of a hidden distribution of profits:

• The agreements between the (controlling) shareholder(s) and the company must be clear, made in advance and recorded in writing and they actually have to be carried out as agreed.
• Services between the company and a shareholder must comply with the arm's length principle.

Which assistance can the tax consultant provide?

A tax consultant can support the company in analysing the current condition regarding German laws and regulations. The idea that the implementation of a tax compliance management system constitutes a complete revision of the current work procedures is a fallacy. Usually, there are already numerous principles and measures designed and in practice to ensure compliance with tax obligations. Therefore, as a first step, these principles and measures should be collected in order to, e.g., develop check-lists from the existing work instructions and guidelines, as a second step. However, it would also be conceivable that the tax adviser supports designing and filling in of so-called risk matrices - with the help of which a risk analysis and assessment should be carried out.

After the status quo has been examined and documented, an external tax adviser can also help to design a strategic tax CMS based on the existing elements and the targets to be determined. In addition, specific requirements of the management (with a view to risk aspects) could be implemented with the help of such a CMS.

In addition to this written provision of documentation of guidelines, check-lists and work instructions, control provisions should be developed. Parts of these control activities can also be made by an outsourced adviser. This could be used as a further protection mechanism since a circumvention of the system is less likely in the case of control by an external third party than in the case of control by an internal body.

Ultimately, however, responsibility for the tax compliance management system rests with the legal representatives of the company - even if the commissioned tax adviser can provide a large number of services and support measures in connection with the analysis, implementation and documentation of a control system.

Conclusion, and tax compliance management by LHP Attorneys at law:

At present, the tax discussion in Germany - not only in the specialist literature - focuses on the subject of "tax compliance". This is due, in particular, to the letter by the Federal Ministry of Finance dated 23/05/2016 amending the Application Degree of the Fiscal Code regarding art. 153 AO and in which the Federal Ministry of Finance outlines the indicator effect of a working tax compliance management system. All clients, of course, wish to safeguard their commercial success also with a view to tax legislation and, therefore, the establishment of a tax compliance management system is advisable. We offer you individual and knowledgeable advice from our tax advisers or tax law experts regarding the subject of "Tax compliance". We can prepare check lists for you and give you instructions and assistance for the day-to-day use. Our firm has comprehensive expertise and the required practical experience as tax lawyers and tax advisers in order to provide the best possible assistance in specific cases. This profound knowledge is continuously expanded within our firm through continuous training of our partners and employees. 

Contributor to this article was:
Linda Zopes
Associate, Tax Adviser, M.Sc. (Business)