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The requirements for reviews by tax courts of add-back estimates

In two sets of legal proceedings, the Federal Fiscal Court (Bundesfinanzhof, BFH) annulled tax court decisions because the reviews of add-back estimates had been deficient. A tax court would thus be deemed to have infringed procedural principles if, in the essential points, it had merely drawn on “publicly available sources on the internet” and had neither documented these sources with a printout nor specifically mentioned them. Furthermore, the BFH called for the principle of procedural equality to be maintained for such reviews.

Reviewing additions to profits

In a decision from 28.5.2020, the BFH reversed a tax court ruling because the sources of the defendant tax office had not been disclosed to the taxpayer who was the claimant and, thus, for whom there was a lack of transparency and no opportunity to present a counter-statement.

In the underlying legal proceedings, the Hamburg tax court had reviewed the add-back estimates for income and sales for a discotheque that a tax office had made in the course of a tax audit. In its ruling from 3.9.2019 (case reference: 2 K 218/18), the tax court had applied a so-called external inter-company comparison and, in the process, had used a gross profit mark-up of 300% as a basis. For this measurement the court made reference, among other things, to a specific internal compilation of standard rates, from the fiscal authority, for discotheques (“Fachinfosystem Bp NRW“ [specialist information system – tax audits NRW]) that was only available in the internal intranet. This source was not made available to the discotheque that had made the claim.

The tax court ruling was annulled by the BFH in its decision from 28.5.2020 (case reference: 1X B 12/20). The tax court drawing on an internal source of knowledge from the fiscal authority constituted a violation of the right of defence. This entitlement includes the right of the parties to the proceedings to comment on the facts relevant to the decision prior to a ruling being issued. Courts are therefore obliged to provide the concerned parties with comprehensive information about all the facts and evidential findings. The tax court did not meet these requirements because, in a way that was relevant to the issue, it justified the estimated gross profit mark-up of 300% with the findings from an internal knowledge source. The contents of this internal compilation of standard rates were not disclosed by the tax court to the discotheque so that it was thus denied the opportunity to comment on the contents.

However, the BFH clarified that the fiscal authority may absolutely create and use its own internal databases for the purpose of estimates. Yet, if a court draws on this collection of data then it has to make it possible, in the manner required by law, for the audited company to acquire the same level of knowledge as the opposing party (the tax office). In this respect, the BFH made reference to maintaining procedural equality. It is now up to the tax court to either change or provide a more transparent justification of the estimated gross profit mark-up.

Sources in the case of add-back estimates in a tax audit

According to the procedural rules for tax courts, the courts have to make decisions based on their freely arrived at convictions gained from the overall outcome of the proceedings. When making their decisions they have to take into consideration:

  • the written statements of the concerned parties,
  • their arguments at the oral proceedings,
  • their conduct,
  • the tax records,
  • the files used,
  • the information,
  • official documents and
  • evidential findings obtained.

The BFH has now highlighted the consequences that a breach of these principles can have.

In the case in question, (BFH decision from 23.4.2020, case reference X B 156/19) there was a dispute over the findings from a tax audit of an ice cream parlour. In the light of several formal deficiencies in the cash register and record-keeping, the auditor had carried out a “yield calculation” and had based his computations on, among other things, the ice cream parlour’s sugar purchases. The Lower Saxony tax court classified the estimated income as being legitimate and declared that the sugar amounts that had been used as the basis for the auditor’s calculations had come from “publicly available sources on the internet”.

The BFH has now annulled the tax court decision because of a procedural flaw and it made reference to the fact that the tax court had not gained its conviction from the overall outcome of the proceedings because it had merely invoked an unnamed internet source. It was therefore not possible for either the parties to the proceedings or the BFH to verify if the sugar amounts included for the purposes of the estimate where indeed justifiable.

Outlook: In this second case, the BFH likewise annulled the decision of the tax court and referred the matter back to it. That is why the tax court now has to provide a more specific description as to the circumstances on the basis of which it had deemed the sugar amounts taken into account to be legitimate. In the first case, a more transparent justification with regard to the surcharge rate to be applied is required at the very least.

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