International Tax Audit (Joint Audit)

Assessment of international circumstances in cross-border trade of goods and services

For German companies and their owners, company tax audits by the Tax Authority are a regularly recurring event, which invokes about as much anticipation as a visit to the dentist. In the end, all company owners who are subject to a company tax audit are relieved when it’s finally over and the result is not too painful (in the meaning of having to pay back taxes). Nobody appreciates the tax office inspector snooping in their documents. There is the further risk of a significant amount of back taxes payable, which are based on arbitrary assessments resulting from the company tax audit, or even criminal proceedings for tax fraud. International tax affairs are daily business in times of the European Single Market and progressing globalisation. The complex issues of international tax law are often neglected, contrary to what is expected by the Tax Authority and the tax auditors. Joint audits enable the Tax Authorities and company tax auditors to jointly conduct tax audits with the tax auditors of other countries. The procedural instrument of a joint audit is increasingly being used. A joint tax audit means, that the company tax audits are simultaneously conducted by the tax authorities of two countries. The legal basis for joint tax audits are Sec 12 EU-Administrative Assistance Act (AmtshilfeRL) and § 12 in connection with §§ 5, 10, 11 EU-AHiG. The concrete implementation of § 12 EU-AHiG was laid out by the Minister of Finance in a letter dated 29.05.2012.

LHP Attorneys at Law assist in international company tax audits (joint audits) as tax law specialists and tax advisers.

The focus of attention in joint audits is, from the view if the German tax administration, the principles applying to transfer pricing as set out in § 1 Foreign Tax Act (Außensteuergesetz AStG). Further more, other provisions of the Foreign Tax Act (AStG) such as the standards applying to the transfer of functions and the differentiation between active and passive companies, as set out in §§ 7 et sqq AStG, are the subject of joint audits. For the Tax Authority. these joint audits greatly facilitate the determination of relevant facts and their assessment in taxation. They are not restricted to one (national) fragment, but obtain an understanding of the big picture, which comprises the national and international fragments. Today's possibilities for digital access enable the auditor, to verify the compliance of documented transfer prices with the daily business practice of the company, virtually at the touch of a button. If the joint audit discovers discrepancies, criminal proceedings for tax fraud are usually not far off. 

The tax authorities involved are given the opportunity of a coordinated and active cooperation, encompassing much more than the mere exchange of information. The tax authorities of both countries have direct access to data and documents, which would otherwise only be available by way of a lengthy and tedious request for administrative assistance. Currently, the Tax Authority and its company tax auditors mainly utilize joint audits in North Rhine-Westphalia and Bavaria. Belgium, the Netherlands and Luxembourg are the responsibility of North Rhine-Westphalia’s company tax auditors. The Bavarian company tax auditors cooperate in joint audits with tax auditors from Austria and Italy. In the future, company tax auditors from Baden-Wuerttemberg will be responsible for France and Switzerland. It is only a questions of time, when countries like Denmark, Sweden, Finland, Poland, the Czech Republic etc. are added to this list.

Which Tax Authority is responsible for joint audits within the European Union?

The responsibility for conducting a joint audit depends on the legal basis for the joint audit. In addition to the EU-provisions for administrative assistance (EU-AHiRL), the double tax treaties (DTT) or the convention on administrative assistance by the OECD and the Council of Europe may apply. As far as these regulations are relevant, they will be applied concurrently to the provisions contained in §§ 193 et sqq of the Tax Code (Abgabenordung, AO) and the rules for company tax audits (BpO, which is a procedural regulation and not a law).

Responsibility for joint audits under Art 12 II EU-AHiRL in connection with § 12 EUAHiG

The general responsibility for company tax audits within the EU rests with the Federal Tax Authority in Bonn (Bundeszentralamt für Steuern, BZSt) and the respective Tax Authority of the German Federal State. It is the responsibility of the BZSt, to forward all information received by the State Tax Authority to the foreign tax authority. Further more, the BZSt also has decision-making authorities. These vary depending on the type of audit, which means that there are differences between an outbound case (investigation of a German company in a foreign country) and an inbound case (investigation of a foreign company in Germany).

Outbound case:

If the joint audit is instigated by a German Tax Authority, this authority must first contact the BZSt. The BZSt will then make a discretionary decision, whether it will agree with the foreign country on the performance of a joint audit. If the application by the Tax Authority is approved, the BZSt will make contact with the respective liaison office in the foreign country.

Inbound case:

If a foreign country instigates the joint audit, the right to make a discretionary decision by the BZSt only exists on paper. In reality, the BZSt is obligated under § 12 Sec 3 lit 1 EuAHiG, to forward the request for a joint audit to the State Tax Authority (=Tax Authority) in charge. The latter will then decide, if it will participate in the joint audit. If a request for a joint audit is refused, the refusal must be substantiated.

The BZSt is further responsible for the coordination of the concrete performance of the company tax audit. The BZSt may however assign this responsibility to the highest State Tax Authority in charge (§ 3 II EU-AHiG).

Which Tax Authority is responsible for joint audits with non-EU-member countries?

The authority for joint audits with non-EU-member countries differs from those with EU countries. In addition to the Finance Administration Act (Gesetz über die Finanzverwaltung, FVG), the respective standards contained in double tax treaties (DTT) govern jurisdiction. Further more, regulations pertaining to jurisdiction may also be contained in administrative assistance treaties, which Germany has established with many countries. This not only applies to joint audits with non-EU-member countries, but also for joint audits with EU-member countries. 
Under the model double tax treaty (DTT-MA), the exchange of information (Art 26 OECD-MA) and the decisions in ambiguous individual cases shall be performed by the responsible authority in the meaning of Art 3 lit f OECD-MA. In Germany, this places the responsibility with the Federal Ministry for Finances (BMF). The BMF may however delegate this task to the BZSt under § 4 III FVG.

What are the prerequisites for a joint audit to be conducted?

Following the purpose of § 12 EU-AHiG, a joint audit is conducted to prevent double taxation of companies operating internationally. The aim of this regulation is to agree on the country-specific allocation of taxable income before settlement negotiations become necessary (which entail long, difficult and possibly fruitless negotiations after the conclusion of a company tax audit). In the best case, the allocation of taxable income (profits) is established at the end of the joint audit and double taxation is thereby avoided. Joint audits may only be instigated by the tax authorities of the concerned countries. The person or company affected is currently not entitled to instigate a joint audit. If a joint audit is to be conducted on the initiative of a tax authority, the concerned taxpayer or company must be heard prior to making a decision on a joint audit. This entitlement to a hearing is set out in § 117 AO, because a joint audit is considered a sub-type of administrative assistance. It is not mandatory to conduct the hearing prior to the commencement of the joint audit. It may however be omitted provisionally, if the audit’s success would otherwise be jeopardized. The hearing must then take place at a later time.

What does a joint audit entail?

A joint audit entails the simultaneous deployment of domestic tax auditors and foreign tax auditors acting on foreign territory. The domestic tax auditor is bound by the applicable national laws. It is however debatable, which laws apply for a foreign tax auditor acting on foreign territory. Currently, the foreign tax auditor is NOT granted his own jurisdiction and investigative authorities. It would however be possible, to grant separate rights to foreign tax auditors in their capacities as appointed authority in Germany. This has however never been implemented.

The scope of the joint audit in respect of temporal and factual extent is agreed between the two tax authorities in an agreement to instigate investigations. The actual company tax audit is conducted by domestic and foreign company tax auditors. Each office of the Tax Authority may thereby partake in an audit of the respective other country, §§ 10, 11 EU-AHiG. This possibility should however not lead to a situation, where a uniform joint audit is conducted. Participation in a joint audit shall only serve the exchange of information.

How is a joint audit concluded?

The joint audit shall assess the taxation affairs in a comprehensive and final manner. The aim of the participating auditors is to develop a mutual result that avoids any double taxation. Unfortunately, this aim is not always achieved in reality, and unfortunately there is no statutory obligation to come to an agreement. If the taxpayer and the company tax auditors have agreed on a result for tax assessment purposes, an audit agreement evidencing the results of the audit is entered into. Tax assessment notices are then issued based on this agreement. If an agreement between the partaking company tax auditors cannot be reached, the negotiations are continued in a formal mutual agreement procedure under Art 25 OECD-MA. This is based on the prerequisite, that the taxpayer submits an application for a mutual agreement procedure to the BZSt after being notified by the Tax Authority or the BZSt of the failure to come to an agreement. In this respect, it is beneficial for the mutual agreement procedure to be conducted by the persons already involved in the company tax audit.

How are the rights of a taxpayer protected in a joint audit?

It lies in the nature of things, that the conduct of a joint audit entails the exchange of sensible taxation data between the tax authorities of the partaking countries. It may seems as if this jeopardizes the safeguarding of tax confidentiality (§ 30 AO). § 30 IV AO prescribes, that an exchange of information is only permissible, if provided for by law. § 117 AO is such a regulation. Under this regulation, the Tax Authorities are entitled to share the taxation data concerned, as far as tax confidentiality is guaranteed in the other country. In the case of a joint audit, tax confidentiality is legally protected by Art 16 I and Art 17 IV EUAHi-RL, which is binding for all EU-member countries. The method of data transmission must be secure and sufficiently protected against access by third parties. This is usually the case, if the exchange of data is performed using a European CCN/CSI platform.

What legal protection is awarded in respect of the transfer of information?

The taxpayer may legally object to the transfer of information in a joint audit. He may commence proceedings at the Fiscal Courts for this purpose. For prophylactic relief, he may apply for an order to desist from the transfer of information by way of temporary injunction as set out in § 114 FGO. If information has already been reported in joint audit, there is, in addition to the injunction, the possibility of declaratory action (§ 41 FGO) in respect of the unlawfulness of the report. It must be verified in such a case, whether the conditions stipulated by § 117 AO in connection with the respective standard of the EUAHiG/EUAHiRL or the standards of the applicable DBA are met.

What legal protection is available against measures taken by the foreign administration on domestic territory?

The administrative measures of a company tax auditor can only be assessed by a court in the country granting his authorities. This means, that the actions of an Austrian company tax auditor acting in Germany must be challenged in Austria. German laws have no territorial or legal jurisdiction in such a case. It follows, that a German tax official acting in a foreign country can “only” be held liable in proceedings before a German Fiscal Court.

Which costs are entailed by a joint audit?

A joint audit does not give rise to administrative costs for the taxpayer. It is however obvious, that consulting and advice for the coordination of the audit entails additional costs for the affected taxpayer or company. These additional costs are usually a sound investment, because costly and drawn-out disputes before arbitrators and courts can be avoided, if a joint audit is concluded successfully. The costs of advice entailed by a settlement or arbitration are also no longer relevant. In addition, the costs for advice in a joint audit are tax-deductible operational expenses.

Our conclusion on joint audits:

Joint audits are a new procedural method and call for a critical assessment and further development. The unresolved issues in respect of jurisdiction are the main deficits. Irrespectively, joint audits are a good and due approach in times of cross-border trade of goods and services. Joint audits can resolve disputes about transfer pricing and thereby save much time and effort, which is a benefit.