Germany has a long-standing and well-established system and practice of disputes and litigation in tax matters. Where a taxpayer deems a tax claim asserted against him or her by the tax authorities to be unlawful, he or she is constitutionally entitled2 to have the governmental action in question reviewed by the courts. It is common practice for taxpayers to exercise that right. As a rule, such disputes are handled in a solution-oriented and constructive manner by all persons and authorities involved. German tax officials do not take it personally if a tax claim asserted by them is submitted to the courts for review. Only very rarely does such a dispute escalate into a heated confrontation.
Importantly, when faced with a potentially unlawful tax assessment notice, a taxpayer is not obliged (and usually not even allowed) to immediately turn to the courts for assistance. Rather, the taxpayer is entitled (and usually legally required) to first challenge the assessment before the authority that issued the notice. This out-of-court remedy is referred to as an administrative appeal. The administrative appeal procedure, which precedes any actual litigation, has a dual function: to relieve the courts and to afford the tax authorities a chance to double-check their own tax assessment notices.
It is very common for taxpayers to exercise their right to challenge a tax assessment notice or other action of a tax authority. According to statistics published by the German Ministry of Finance, between 3.24 million and 5.24 million administrative appeals were lodged annually over the past few years (from 2009 to 2017). These administrative appeals were often successful, thus eliminating the need for court proceedings. In more than two-thirds of cases, the administrative appeal prompted the tax authorities to amend the action challenged (e.g., the tax assessment notice) as requested. Generally speaking, administrative appeal proceedings take three to 12 months.
If the taxpayer's administrative appeal is not fully granted, the tax authority needs to issue a formal decision of refusal (the administrative appeal decision). The taxpayer may then submit this decision to the regionally competent tax court for judicial review. Alongside the ordinary branch of the judiciary, which deals with civil and criminal law matters, the German judiciary comprises special branches (with specialised judges) for labour (general), administrative, social and tax law. The structure of the tax branch is particular in the sense that it is the only branch that only consists of two court levels: the regional (first instance) tax courts and the Federal Tax Court in Munich.
Organisationally, the tax courts are entirely separate from and independent of the tax authorities; they are also fully independent and not in any way subject to instructions when adjudicating on the lawfulness of measures taken by the tax authorities. However, it should be mentioned that the traditional career path of a tax judge starts in the tax authorities, and even though in recent years a number of tax courts have increasingly started to recruit tax specialists from law firms, others are still strongly dominated by former public servants (which, according to unofficial statistics, has an adverse impact on taxpayers' success rate). Germany has a total of 18 lower (first-instance) tax courts. Over the past few years (2009 to 2017), an average total of about 37,900 new legal actions were filed annually with these courts.
While tax court proceedings take two years on average, this varies significantly depending on the workload of the relevant court division, and also on the question of to what extent the court first needs to establish the facts of the case before it. As one might expect, if the facts of a case prove difficult to establish, this will delay proceedings.
As a rule, the tax courts adjudicate by way of a judgment that upholds, reverses or amends the administrative appeal decision rendered by the tax authority. Given the amount of work involved in drafting a judgment, judges are keen to terminate proceedings in a way that eliminates the need for a formal judgment. If, upon closer examination, the court considers a case to be clear-cut, the parties are often told about the decision the court is contemplating during a hearing. Frequently, the court suggests that the tax authority amend the administrative action challenged (e.g., the tax assessment notice) in favour of the taxpayer to prevent a judgment against the tax authority. In other cases, the court might advise the taxpayer to withdraw his or her action. About two-thirds of all proceedings are terminated in one of the above ways, without any judgment being passed.
Of those cases in which a judgment has been passed, only about 20 per cent are (in whole or in part) in favour of the taxpayer. The latest statistics show that this percentage stabilised after a slight decrease in 2015 at approximately 19 per cent in 2017. One important reason why taxpayers have such a low rate of success before the tax courts would seem to be the fact that there is no legal requirement to be professionally represented before the tax courts, unlike in proceedings before the German Federal Tax Court. As a result, many taxpayers take legal action without the involvement of an experienced German qualified lawyer or German qualified tax consultant.
If the losing party deems a judgment rendered by a court of first instance to be incorrect, that party may lodge an appeal with the Federal Tax Court. As a rule, however, this option is subject to the lower tax court having granted leave to appeal ('revision': a judicial appeal restricted in scope to questions of law). Revision proceedings before the Federal Tax Court take an average of 20 months. More than 41 per cent of these cases are decided in favour of the taxpayer.
Proceedings before both the lower tax courts and the Federal Tax Court are subject to court fees. The amount of these fees depends on the value of the matter in dispute. By way of example, a legal action involving a value of €500,000 triggers fees of €14,144 for proceedings before the tax courts and €17,680 for revision proceedings before the Federal Tax Court. However, these fees are to be borne by the taxpayer only if and to the extent that he or she loses; a taxpayer who is fully successful does not have to bear any court fees. Administrative appeal proceedings before the tax authority never trigger any fees. By contrast, the costs for professional advisers in tax matters (lawyers or tax consultants) are, in principle, to be borne by the taxpayer. However, if and to the extent that the taxpayer wins in court (i.e., the action before the lower tax court or the revision proceedings before the Federal Tax Court), the tax authority usually has to bear such advisers' costs, albeit capped at the relevant statutory amount of advisers' fees.
II COMMENCING DISPUTES
i Subject matter of the dispute
Typically, disputes between a taxpayer and the tax authorities are about the lawfulness of a tax assessment notice. Under certain circumstances, however, a tax assessment notice is preceded by preparatory administrative decisions that constitute a binding basis for the subsequent tax assessment notice. More specifically, from a German tax perspective (under what is known as the transparency principle), partnerships are not themselves subject to income tax or corporate income tax but rather – and solely – their partners are, whether they are natural persons or corporate bodies. The profits attributable to the individual partners are determined by the tax authority that is competent for the partnership as such, and they are included in a formal separate notice of assessment that, in turn, is binding for the purposes of the personal tax assessment notices of the individual partners. If a partner regards the separate assessment notice as unlawful, he or she may not challenge the (subsequent) personal tax assessment notice but must contest the underlying separate assessment notice.3 Statute provides for such declaratory notices of assessment in numerous situations.4 One such group are cross-border scenarios: for example, those involving the German controlled foreign company rules, also referred to as add-back taxation.5 In the context of local taxes – for example, trade tax – similar preparatory assessment notices are provided for (e.g., fixing the tax base for the relevant type of tax, to which the competent municipality will then apply the respective tax rate). Any separate or preparatory assessment notice that is considered unlawful by the taxpayer must be challenged before the issuing authority (and normally within one month). It is imperative not to wait until the subsequent tax assessment notice, which is based on the separate or preparatory assessment, has been issued.
ii Tax dispute resulting from a tax audit
The German tax authorities normally accept the statements and data provided in the taxpayer's tax return. It is usually only subsequent tax audits that spark disputes. The tax authorities are entitled to use their findings from tax audits by amending existing notices (tax assessment notices, but also separate and preparatory assessment notices). Thus, to the extent that the findings from a tax audit lead to a higher tax burden, existing notices may be amended to the detriment of the taxpayer. Before amending the notices, the tax auditor completes the audit by preparing an audit report on his or her findings. Such audit reports, however, may not be challenged. Rather, it is only the notices issued by the tax authority in the wake of the audit report that may be submitted by the taxpayer to the courts for review once an administrative appeal procedure has been unsuccessful.
The question of whether, and if so in what intervals, a tax audit is carried out regarding a taxpayer normally hinges on the size and level of turnover or profits of the enterprise concerned. The legal default is for large enterprises as well as groups of companies to be subject to tax audits in relation to each fiscal year. Very small enterprises and taxpayers with a low income are audited only exceptionally. Extraordinary transactions or anomalies, however, may trigger tax audits even where lower levels of turnover of profits are involved (e.g., in the case of inconsistencies in the tax return or in the context of restructurings). Moreover, in particular as regards transactions with an international dimension (e.g., transfer pricing), local tax auditors may be supported by specialists from the Federal Central Tax Office.
iii Administrative appeal procedure
Before a judicial review of the lawfulness of a separate or preparatory notice of assessment or of a tax assessment notice may be sought, the administrative appeal procedure before the tax authority must be completed. This procedure serves the dual purpose of the tax authorities double-checking their own decisions and the caseload of the tax courts being reduced. The administrative appeal must be lodged by the taxpayer with the issuing authority within one month after the taxpayer has received the relevant notice.6 The taxpayer is not, however, required to provide the grounds of his or her appeal within that one-month period; these may be submitted later. An administrative appeal may also initially be lodged as a precaution; for example, if, as the one-month time limit is about to expire, it remains unclear whether or not a notice is lawful. As mentioned earlier, administrative appeal proceedings usually take three to 12 months. In certain circumstances, however, the administrative appeal procedure is excluded. In these cases, the taxpayer has to take legal action directly against the assessment notice. Practically speaking, these cases are rather rare (e.g., in the context of certain mistakes contained in trade-tax assessment notices).
iv Judicial proceedings
If the administrative appeal fails, the tax authority rejects it by way of a formal decision referred to as an administrative appeal decision. The taxpayer is entitled to have the lawfulness of any such administrative appeal decision reviewed by the courts. In general, the tax courts are competent to hear such cases. In very rare cases, the measure adopted by the tax authorities needs to be challenged before the general administrative courts.
As a rule, any legal action challenging an administrative appeal decision needs to be filed with the competent tax court within one month of the taxpayer having been notified of the tax assessment notice.7 The question of which of the 18 lower tax courts is regionally competent to hear the case hinges on which tax authority issued the administrative appeal decision being challenged. The action brought by the taxpayer must clearly identify the specific decision that is being challenged. Moreover, the plaintiff must indicate which rights he or she deems breached. It is not obligatory to substantiate the complaint within the one-month time limit.
Once the complaint has been filed, the competent division of the tax court sets a time limit within which the legal action must be substantiated; this is usually within four to six weeks from the filing of the claim. In complicated cases, the time limit for substantiation may be extended upon application.
Once the claim has been substantiated, the tax authority is given the opportunity to submit its response. Any such response by the tax authority may, in turn, be commented on by the taxpayer in a written reply, and usually the tax authority will be given the opportunity for a rejoinder. The written procedure is not legally limited to two statements by each side, but only in very complex cases will a further exchange of written arguments take place. Usually, the exchange of written pleadings between the parties is completed within about six months of the claim having been substantiated. The further course of judicial proceedings very much depends on the nature of the questions at the heart of the legal action. If the focus is on establishing questions of fact, the court will take evidence. Predominantly, evidence is taken by hearing witnesses and examining documentary evidence; in some cases, experts are consulted. Evidence is taken during a hearing. As a rule, judicial proceedings are completed more quickly if the dispute exclusively involves questions of law. Upon completion of the hearing, the court passes judgment on whether the legal action is admissible and successful on the merits.
Courts are usually keen to bring proceedings to a conclusion without the need for a judgment. The two reasons for this are that drafting a formal judgment involves a significant amount of effort, and judgments do not necessarily truly settle disputes in the sense of creating a lasting legal concord.
If the court has formed its opinion and estimates a case to be clear-cut, it will often indicate to the parties the decision they are to expect. If the judges consider the legal action to be justified, they may invite the tax authority to amend the administrative action challenged (e.g., the tax assessment notice) in favour of the taxpayer to prevent a judgment against the tax authority. Conversely, if the judges do not consider the case to have merit, they may invite the taxpayer to withdraw his or her action in order to avoid its dismissal and to reduce the court fees. About two-thirds of all proceedings are terminated in one of these ways, without any judgment being passed. As mentioned earlier, average judicial proceedings take about two years.
v Revision proceedings before the Federal Tax Court
If the judicial proceedings before the court of first instance conclude with a judgment that the losing party deems to be incorrect, it may appeal such judgment before Germany's Federal Tax Court. As a rule, however, this option is subject to the lower tax court having granted leave to appeal. If such leave to appeal (revision) has been granted, the losing party can appeal to have the lawfulness of the judgment reviewed by the Federal Tax Court. As mentioned earlier, arguments before the Federal Tax Court are restricted to asserting that the lower tax court erred in its assessment of questions of law. Moreover, the norms allegedly breached must be federal ones (as opposed to ones forming part of the law of the 16 individual German states). In other words, the appellant in revision proceedings is barred from asserting that the facts relied upon by the lower tax court in its decision were inaccurate. Where a losing party believes the facts as assumed by the lower tax court to be inaccurate, that party may achieve a reversal of the judgment rendered by the court of first instance only by successfully asserting before the Federal Tax Court that said judgment had been reached in violation of procedural norms (plea of procedural error). If the Federal Tax Court concurs, it normally refers the legal dispute back to the lower tax court, where first-instance proceedings must then be conducted anew.
Any revision needs to be filed with the Federal Tax Court within one month of the appellant having been notified of the judgment rendered by the lower tax court, and it normally needs to be substantiated within two months thereof.8 Revision proceedings currently take about 18 months on average.
vi Complaint against refusal of leave to appeal with the Federal Tax Court
If the judicial proceedings in the first instance conclude with a judgment with regard to which the lower tax court has refused to grant leave to appeal, the losing party may lodge what is known as a 'complaint against refusal of leave to appeal' with the Federal Tax Court. Such a complaint will be successful if the losing party is able to show that the lower tax court should in fact have granted leave to appeal (revision).
More specifically, the party lodging this complaint must demonstrate that the legal dispute hinged on a question of law that the Federal Tax Court either has not yet ruled upon (thus rendering the matter admissible as being of fundamental significance) or has judged differently from the lower tax court (making the matter admissible on the grounds of divergence).
A complaint against refusal of leave to appeal will also be successful if, before the Federal Tax Court, the judgment by the lower tax court can be shown to have been passed in violation of procedural norms (plea of procedural error). Like other remedies, a complaint against refusal of leave to appeal needs to be filed with the Federal Tax Court within one month of the appellant having been notified of the judgment by the lower tax court, and normally needs to be substantiated within two months thereof.9 On average, the Federal Tax Court decides on the complaint within six months of it being filed.
vii Jurisdiction of Germany's Federal Constitutional Court
If the remedies taken by a taxpayer have proven unsuccessful, and provided all remedies for administrative or judicial review have been exhausted, the taxpayer may file a complaint of unconstitutionality with Germany's Federal Constitutional Court in Karlsruhe. Such a complaint will, however, only be successful if the taxpayer can show that the Constitution has been violated.10 The complaint needs to be filed and substantiated within one month of the complainant being notified of the final judicial decision.11 Complaints of unconstitutionality regarding judgments by lower tax courts or by the Federal Tax Court have occasionally been successful in the past. For example, the Federal Constitutional Court found certain instances of tightening of statutory rules (e.g., in the German Income Tax Act) to be in violation of the constitutional prohibition on retroactivity;12 or that the courts violated the right to a hearing enshrined in the Constitution.13
The time involved in proceedings brought before the Federal Constitutional Court fundamentally depends on the specifics of an individual case. Some complaints of unconstitutionality are decided upon in a matter of months; complaints with a particularly broad impact often take several years.
viii Injunctive relief
The procedures outlined so far are aimed at conclusively resolving matters in dispute. A separate question is whether the amount of tax assessed by the tax authority needs to be paid despite a pending legal challenge. As a rule, any tax assessed becomes due and payable even if an administrative appeal has been lodged with the tax office against the underlying tax assessment notice. The same applies if the tax assessment notice (or, more precisely, the adverse administrative appeal decision confirming it) is challenged before the tax courts.
Therefore, to keep from owing the assessed tax, a taxpayer needs to file (simultaneously with his or her administrative appeal or legal action) an application for suspension of enforcement. Such application should be addressed to the tax authority that has issued the notice in question.14 The authority is obliged to grant the application if a summary examination yields serious doubts about the lawfulness of the notice challenged; in other words, if there are doubts as to the lawfulness of the notice. A suspension of enforcement may also be granted where the payment would cause inequitable hardship for the taxpayer.
If the tax authority rejects an application for suspension of enforcement, the taxpayer may submit that decision to the competent lower tax court for review.15 The lower tax court, for its part, likewise determines whether a summary examination yields serious doubts about the lawfulness of the notice challenged, or a particular hardship warrants the suspension sought by the taxpayer.
The decision of the lower tax court may, in turn, be submitted to the Federal Tax Court for review, provided the lower tax court has granted leave to lodge a complaint against its decision with the Federal Tax Court. Applications for suspension of enforcement are decided upon particularly quickly. Normally, decisions by the tax authorities on such applications are a matter of a few working days. If a lower tax court is called upon to review such a decision by a tax office, the court usually reaches its decision within three to six months of the complaint having been filed. The tax authorities will, however, not proceed to enforce assessed taxes while an application for suspension of enforcement is pending.
ix Legal protection in the context of international double taxation
The remedies outlined above (in particular administrative appeal and judicial proceedings) are also available to taxpayers who seek to challenge any double taxation arising in international scenarios. Cases in which it proves impossible to conclusively ascertain which of the two states is failing to correctly apply the pertinent double taxation treaty (DTT) bear the danger that legal proceedings at a national level will be unsuccessful (because the national courts in each of the two states will uphold the relevant tax assessment notice as lawful). In these cases, the taxpayer is well advised to apply – simultaneously with remedies on a national level where appropriate – for an intergovernmental mutual agreement procedure, or (to the extent possible) for an intergovernmental arbitration procedure to be initiated.
All DTTs entered into by Germany provide (as a minimum) for an intergovernmental mutual agreement procedure to be conducted. Under most treaties, the taxpayer needs to apply for the initiation of such mutual agreement procedure no later than three years from the double taxation having occurred (only a few treaties contain time limits of two or four years, respectively). Upon application by the taxpayer, the competent authorities of the states involved will attempt to eliminate any double taxation by way of mutual agreement. In Germany, the relevant application normally needs to be filed with the Federal Central Tax Office (based in Bonn). The mutual agreement procedure, however, does not afford any entitlement to an actual elimination of double taxation. Nonetheless, in most cases involving Germany, intergovernmental agreements are reached that eliminate or at least mitigate double taxation.
The risk that any existing double taxation will continue unchanged may be minimised by affording the taxpayer a legal right to also apply for the initiation of intergovernmental arbitration proceedings. If such arbitration proceedings are provided for, the taxation conflict is settled by the arbitral award of an independent body. The arbitral award is binding upon both states. Such proceedings ensure that any taxation in violation of the DTT is always eliminated. To date, arbitration proceedings have been provided for in only a few German DTTs. With regard to the allocation of profits among related persons and the attribution of profits between head office and permanent establishment, the EU Arbitration Convention provides for arbitration proceedings to be conducted (upon application by the taxpayer) if it has proved impossible to eliminate, by way of mutual agreement proceedings, taxation that is in violation of the DTT. Within its scope of application, the Convention serves as an important legal basis for combating double taxation in the context of intra-European scenarios. The Convention has consistently proved itself in practice.
III THE COURTS AND TRIBUNALS
i Decisions on administrative appeals
If a taxpayer lodges an administrative appeal against a notice (i.e., a tax assessment notice or a separate notice of assessment), he or she must do so with the authority that issued the relevant notice. Within that authority, the administrative appeal is initially dealt with by the official responsible for the notice in question. If that official regards the administrative appeal as unsuccessful on the merits, it is forwarded to a specialised department within the authority that is exclusively tasked with deciding on administrative appeals (the legal redress department). This ensures that the final decision is not taken by the official who was responsible for the challenged notice. The legal redress department is not bound by the opinion of the official who was responsible for the notice concerned. It may consider the administrative appeal partly or even fully justified, and will then amend the notice accordingly.
ii Decision on legal actions
If the tax authority (partly or fully) rejects the taxpayer's administrative appeal by way of a formal decision, he or she may apply to the competent lower tax court for a review of the lawfulness of that decision. Within the lower tax courts, the organisational divisions entrusted with adjudicating legal actions are referred to as 'senates'. Each senate consists of a total of five judges: three professional judges and two lay judges. In practical terms, the lay judges' influence on the decision is very limited. While they do enjoy equal voting rights, they generally let themselves be guided by the professional judges' vote. Among the three professional judges, it is the presiding judge who is particularly influential. The presiding judge is responsible for the organisation of the senate and presides over hearings. Presiding judges regularly shape the line of decisions taken by their senate.
If the legal dispute is particularly clear-cut in terms of both the questions of fact and the questions of law to be determined, it may be assigned to a sole judge.16 Only professional judges are eligible to act as sole judges. The assignment of a case to a sole judge is designed to speed up the judicial proceedings.
iii Decisions on judicial appeals limited to questions of law and complaints against refusals of leave to appeal
The Federal Tax Court, and more specifically the competent senate in each case, decides on judicial appeals limited to questions of law and complaints against refusals of leave to appeal. Each senate at the Federal Tax Court likewise consists of five judges, but there are only professional and no lay judges. Similarly to the lower tax courts, the line taken by a senate of the Federal Tax Court in its decisions is shaped, in particular, by its presiding judge.
IV PENALTIES AND REMEDIES
i Criminal penalties
Penal sanctions, if any, are not imposed within the framework of disputes on tax matters. Rather, if the tax authorities believe that a taxpayer has committed a tax offence, they will initiate, or cause to be initiated, (separate) criminal proceedings on tax matters against the taxpayer. If the allegations are corroborated, a penalty may be imposed on the taxpayer. Such proceedings are, however, handled by the public prosecutor's office assisted by specialised departments of the tax authorities. Likewise, any possible penal sanctions are imposed by general penal courts rather than tax courts. If a taxpayer is proven to have evaded taxes, he or she is usually fined an amount at least equal to the tax evaded. As a rule, tax evasion in excess of €1 million triggers imprisonment.17
ii Administrative penalties
Administrative sanctions, by contrast, may be imposed as part of a dispute in tax matters. German procedural law in tax matters provides for such sanctions in the event that the taxpayer fails to meet certain obligations to cooperate, either in time or at all. The most important administrative sanctions in tax matters are as follows:
- imposition of a late-filing surcharge of up to €25,000 (if the taxpayer files his or her tax return late or not at all);
- imposition of a non-compliance fine (obstruction fee) of between €2,500 and €250,000 (if the taxpayer fails to comply with reasonable demands for clarification made by the tax auditor, either in time or at all); and
- imposition of a surcharge of up to €1 million (either if the taxpayer fails to prepare any transfer pricing documentation, or any such documentation prepared proves inadequate).
Administrative sanctions are imposed by way of an administrative act whose lawfulness can be reviewed by way of an administrative appeal and subsequent judicial proceedings (see Section II).
V TAX CLAIMS
i Recovering overpaid tax
A taxpayer is obliged to pay taxes only upon having been formally required, by way of a tax assessment notice, to do so. German tax authorities usually refund to the taxpayer any payments made in the absence of an underlying tax assessment notice. The same applies if and to the extent that any tax is reduced by a subsequent tax assessment notice: a possible overpayment is refunded to the taxpayer.
If, in light of the existence of several tax assessment notices, there is uncertainty regarding the amount of tax imposed and the payments made thereon, the taxpayer may request a special notice in which the tax authority is required to detail any tax amounts assessed and any payments made.18 That special notice is referred to as 'statement of account'. If the taxpayer deems the statement of account to be inaccurate, he or she may challenge it by lodging an administrative appeal and subsequently bringing a legal action, where necessary (see Section II). The overpayment by the taxpayer (if any) shown in the statement of account will be refunded to him or her by the German tax authority.
ii Challenging administrative decisions
Administrative acts may only be challenged on the grounds that they are (allegedly) unlawful. The unlawfulness may result from the administrative act being incompatible with the Constitution or with specific tax law provisions. In some cases, the unlawfulness may flow from the fact that the administrative act is not in line with a general instruction of a supreme administrative authority (e.g., a decree by Germany's Federal Ministry of Finance). In other cases, the unlawfulness may result from the taxpayer in question being discriminated against in relation to another taxpayer. For this to apply, the discrimination would need to qualify as an infringement of the fundamental right to equal treatment.19 If, against this yardstick, an administrative measure proves unlawful, it can normally be challenged by lodging an administrative appeal or bringing a legal action (see Section II).
In Germany, the focal point of tax court litigation aimed at enforcing a tax refund claim is the respective underlying tax assessment notice (or separate notice of assessment, as the case may be). Given that the administrative appeal procedure as well as judicial proceedings almost always concern the administrative notice or the separate notice of assessment in question, both the administrative appeal and legal action must, as a rule, be brought by the very taxpayer to whom the relevant notice had been addressed by the tax authority. For example, if the VAT assessed by a tax authority is excessive, then it is the addressee of the VAT notice who may apply for a reduction of the VAT in the context of lodging an administrative appeal or bringing a legal action.
This also applies where several taxpayers are taxed jointly in the context of group taxation (also referred to in Germany as fiscal unity). In group taxation scenarios, the tax authority must address its tax assessment notice exclusively to the group's parent company (not the subsidiaries). That tax assessment notice also needs to take into account the profits or turnover of the other group members. If the profits or turnover of any one group member – as taken into account in such a tax assessment notice – are too high, then it is not that group member company that is entitled to lodge an administrative appeal or bring legal action, but the company to which the relevant tax assessment notice was addressed (usually, the group's parent company).
Only in exceptional cases may a tax assessment notice be challenged (by way of an administrative appeal or legal action) by someone other than that notice's addressee. For example, a taxpayer may bring legal action against a tax assessment notice that exempts one of his or her competitors from taxation. Such an option for third parties to bring legal action requires, however, that the relevant tax statute applied is relevant to competition (which is only rarely the case). It is, however, conceivable that competitors' complaints could be based on the violation of EU state aid rules, if applicable.
Proceedings before both the lower tax courts and the Federal Tax Court are subject to court fees. The amount of these fees depends on the value of the matter in dispute. However, such court fees are to be borne by the taxpayer only if and to the extent that he or she loses (see Section I). For illustration purposes, the following table shows the amount of court fees due for a legal action involving a value of the matter in dispute of €300,000 (or €3 million or €30 million, respectively):
|Value of the matter in dispute||Fees for administrative appeal proceedings before the issuing authority||Fees for legal action before the lower tax court||Fees for revision proceedings before the Federal Tax Court|
|€3 million||No fee||€50,144||€62,680|
|€30 million||No fee||€438,944||€548,680|
By contrast, the costs for taxpayers' professional advisers in tax matters (lawyers or tax consultants) are, in principle, to be borne by the taxpayer. If and to the extent, however, that the taxpayer wins in court (i.e., the legal action before the lower tax court or the revision proceedings before the Federal Tax Court), the tax authority has to bear such advisers' costs, albeit capped at the relevant statutory amount of advisers' fees.
VII ALTERNATIVE DISPUTE RESOLUTION
As far as tax disputes involving exclusively national (German) scenarios are concerned, dispute settlement instruments have not acquired any significance to date. More specifically, mediation proceedings in tax matters have been discussed by experts but have failed to be introduced. At the same time, there is a widespread use among practitioners of instruments aimed at avoiding tax disputes from the outset (preventive avoidance of disputes).
i Binding ruling for the purposes of settling questions of law
To the extent that conflicts in terms of diverging positions regarding certain legal issues are anticipated, the taxpayer may apply to have the matter clarified in advance by way of a binding ruling. Binding rulings are only issued, however, provided the underlying scenario has not yet been (fully) realised. In other words, a binding ruling cannot be issued with regard to fact patterns that occurred in the past.20 Accordingly, it is important to apply in good time for any binding ruling to be sought. The General Tax Code expressly restricts the scope of binding rulings to questions of law; accordingly, binding rulings may not be sought in relation to questions of fact. Thus, a taxpayer may not ask a tax authority to specify the fact pattern on which it intends to base its decisions; binding rulings are not available to achieve clarification of uncertainties as to the facts of a particular case. Similar to court fees, the fee due (if any) for the issuing of a binding ruling depends on the amount of tax involved. More specifically, a binding ruling is subject to fees if the tax effect of the underlying legal issue amounts to €9,999 or more. If the tax effect amounts to, say, €10,000, the fee is €241; if it amounts to €30 million, the maximum fee of €109,736 is levied.
ii Binding commitment for the purposes of settling questions of law
Rulings applied for by and provided to the taxpayer in the course of a tax audit are not subject to any fees.21 This type of ruling is referred to as a 'binding commitment'. This instrument, too, is expressly restricted to questions of law by the applicable statute; binding commitments may not be sought for questions of fact. What is more, when seeking a binding commitment, it is compulsory to delineate the relevant underlying fact pattern.
Furthermore, the fact pattern for which a binding commitment on questions of law is sought needs to form part of the subject matter of the tax audit and possess relevance for the future (i.e., beyond the tax audit).
iii Advance pricing agreements (APAs) regarding transfer prices
APAs are a useful instrument to prevent disputes regarding transfer pricing matters. The tax authorities have been prepared for more than a decade to participate in APAs. Since 2006, APAs have been subject to fees. The basic fee is €20,000.22
The German APA programme is designed to resolve actual or potential transfer pricing disputes in a systematic and cooperative manner.
APAs are about agreements to be reached beforehand, and thus for the future; between affiliated companies (and thus taxpayers) and the tax authorities of the relevant states; and on the transfer prices to be applied for a certain period.
Transfer prices are usually agreed in advance for a future period of three to five years.
From a German perspective, APAs involve two distinct relationships: the intergovernmental level, which exclusively concerns the tax authorities of the states in question; and the domestic level, which concerns the relationship between the national German tax authority and the relevant taxpayer.
At the intergovernmental level and in the context of a mutual agreement procedure, the tax authorities of the states concerned agree upon specific transfer prices as binding for defined future periods. In Germany, the binding effect (domestically) of such an intergovernmental agreement is brought about by a separate agreement between the German tax authorities and the taxpayer resident in Germany.
The Federal Central Tax Office in Bonn is competent for handling the APA procedure. If a German taxpayer wishes to initiate an APA procedure, he or she needs to set out the proposed transfer prices in the context of a preliminary discussion (pre-filing) with the responsible official of the Central Tax Office. If this official deems the proposed (or an amended) transfer price achievable on an intergovernmental level, the taxpayer is invited to formally apply for an APA procedure to be conducted regarding this transfer price. That application then becomes the basis of the intergovernmental part of the APA procedure, which solely involves the tax authorities of the states concerned. Once the participating authorities have agreed a specific transfer price, the taxpayer is notified accordingly.
For the agreed transfer price to become binding domestically (i.e., in Germany), the taxpayer needs to consent to this transfer price in writing to the German tax authorities and formally undertake not to challenge any corresponding tax assessment notices in the future.
The tax authorities may then base future tax assessments on a different transfer price only where certain crucial assumptions integral to the APA fail to materialise during the relevant period, thus making it reasonable for a different transfer price to be applied.
For the most part, German taxpayers' experience with the handling of APA procedures by the German tax authorities is very positive. The APA procedure has its merits, especially where other procedures fail to afford adequate protection against double taxation.
The APA procedure is particularly helpful in constellations in which transfer prices cannot easily be determined, and there is a simultaneous lack of intergovernmental arbitration procedures in relation to the states concerned.
iv Dispute resolution regarding questions of fact
Once a tax dispute is pending, the German tax authorities are barred from accepting any compromise regarding questions of law. As far as such questions of law are concerned, the fundamental principle of lawfulness of taxation (enshrined in the Constitution) is interpreted as obliging the tax authorities to strictly apply the law. That is also why amicable agreements on questions of law are bound to fail.
By contrast, if a dispute is not about questions of law but questions of fact (i.e., about the precise facts that have occurred in a particular case), the tax authorities may reach a settlement agreement (understanding on questions of fact), thus establishing the facts on which taxation should be based in a particular case.
Such understandings on questions of fact very frequently enable the parties to amicably settle existing tax disputes. The responsible tax officials will, however, consent to such a settlement only provided it can be made very clear that the compromise exclusively extends to questions of fact (as opposed to questions of law). In practice, this is feasible in a large number of cases. While such understandings on questions of fact are usually reached in the context of a tax audit, they are also employed in the course of judicial proceedings before the tax courts.
The German legislator has introduced special anti-abuse rules targeting certain specific constellations. Anti-abuse rules are also contained in some German DTTs. In cases that do not fall within the scope of the special anti-abuse rules, the tax authorities seek to rely on the general anti-abuse rules codified in Section 42 of the General Tax Code.
That umbrella provision stipulates that a structure is deemed abusive if it involves an inappropriate legal structure or, when compared to a (hypothetical) appropriate structure, it leads to a tax advantage not contemplated by statute. It further stipulates that, conversely, no abuse is deemed to exist where the taxpayer can demonstrate that his or her structure was motivated by non-tax reasons. There is a host of case law regarding the question under which circumstances an abuse is to be assumed to exist.
IX DOUBLE TAXATION TREATIES
Generally, the DTTs entered into by Germany are limited to income tax, corporate income tax, trade tax and inheritance tax. These DTTs are thus of no assistance in eliminating double taxation in the area of VAT. Avoidance of double VAT taxation is, however, effectively ensured by a uniform application of the VAT Directive as overseen by the European Court of Justice. As a result, at least in scenarios within the EU, the risk of double VAT taxation is low.
Over the past few years, the Federal Tax Court has repeatedly found elements of German taxation to be incompatible with the relevant DTTs. These judgments mainly concern income tax, corporate income tax and trade tax, and often involve the taxation of individuals.
In several cases, the Federal Tax Court has clarified the enormous importance of clauses in DTTs that – congruent with Article 9(1) of the OECD Model Tax Convention – allow for income adjustments based on the 'dealing at arm's-length principle' in relations between associated enterprises. The Court has ruled that such clauses do not aim at the immediate correction of profits but at their bilateral demarcation, and that profit corrections under domestic law are therefore limited to elements affecting the amount of the transfer price. If, however, the tax authorities bring forward purely formal objections to the handling of the business relationship between the associated enterprises, the provision of the DTT has an overriding effect.23 In other words, the treaty-based 'arm's-length' principle only allows an income adjustment based on a domestic rule where the price agreed between associated enterprises is inappropriate as to the amount. For this reason, the tax authorities are not entitled to adjust the depreciation of a loan merely because the domestic parent had issued the loan to its foreign subsidiary without any security and, therefore, in a way that would have to be considered 'unusual' among unrelated parties.24
A 2011 judgment was the first to expressly address the tax treatment of private equity funds. It dealt with the taxation of two corporations resident in Germany that had invested in a private equity fund set up as a UK limited partnership. In that specific case, the Federal Tax Court held that, under the DTT between the UK and Germany, the German investors were not subject to tax in Germany on their income from the fund. Simultaneously, that income was exempted from taxation in the UK under the provisions of UK law. The Federal Tax Court emphasised that the DTT has to be respected even where the income is not taxed by the other state either.25 This principle was confirmed by the Federal Tax Court in a judgment of 11 January 2012.26
X AREAS OF FOCUS
Given that most disputes in tax matters originate from arguments in the context of tax audits, the tax audits currently underway allow a fairly accurate forecast of which issues are likely to become the subject of judicial proceedings in the future. Looking at current tax audits and taking into account the most recent important statutory amendments, transfer pricing issues in particular are likely to be fought out before the courts. This applies especially to the area of relocation of functions, as the pertinent rules have been tightened in recent years. Other areas in which a significant number of disputes is to be expected in the future include the secondment of employees and (national and international) restructuring.
It should also be mentioned that protection under EU law is taken very seriously by German tax courts. The German Federal Tax Court, in particular, is the court with the highest number of references to the European Court of Justice in the whole of the European Union. Apart from EU law questions related to customs duties, VAT and excise duties, German tax courts have been playing a major role in the development of protection of individuals and enterprises under the fundamental freedoms, and a new area that is currently being explored is that of EU state aid law.
XI OUTLOOK AND CONCLUSIONS
No major changes are anticipated that might affect the German system and practice of disputes and litigation in tax matters. A recently introduced act is expected to accelerate judicial proceedings in the medium term, as it enables taxpayers to challenge excessively lengthy proceedings more efficiently. Another improvement for taxpayers expected in the medium-term concerns their protection against double taxation, as the German tax authorities are undertaking considerable efforts to negotiate new DTTs with arbitration clauses, which would extend taxpayers' protection beyond mere mutual agreement procedures. Together, these measures should ensure that Germany's level of legal protection in tax matters, which is already fairly good, will be further improved.
1 Axel Cordewener is of counsel and Michael Hendricks is a partner at Flick Gocke Schaumburg.
2 Article 19, Paragraph 4 German Constitution.
3 Section 351, Paragraph 2, General Tax Code.
4 See generally Section 180, General Tax Code.
5 See the special provision in Section 18, Foreign Tax Act.
6 Section 355, Paragraph 1, General Tax Code.
7 Section 47, Paragraph 1, Code of Procedure for Fiscal Courts.
8 Section 120, Paragraphs 1 and 2, Code of Procedure for Fiscal Courts.
9 Section 116, Paragraphs 2 and 3, Code of Procedure for Fiscal Courts.
10 Section 90, Paragraph 1, Law on the Federal Constitutional Court.
11 Section ۹۳, Paragraph ۱, Law on the Federal Constitutional Court.
12 Federal Constitutional Court, order of 7 July 2010, Case No. 2 BvR 748/05 et al.
13 Federal Constitutional Court, order of 13 April 2010, Case No. 1 BvR 3515/08.
14 Section 361, General Tax Code.
15 Section 69, Code of Procedure for Fiscal Courts.
16 Section 6 Code of Procedure for Fiscal Courts.
17 Federal Court of Justice (Criminal Division), judgment of 2 December 2008, Case No. 1 StR 416/08.
18 Section 218, Paragraph 2, General Tax Code.
19 Article 3, Paragraph 1, Federal Constitution.
20 Section 89, General Tax Code.
21 Section 204 et seq., General Tax Code.
22 Section 178a, General Tax Code.
23 Sperrwirkung, judgment of 11 October 2011, Case No. I R 75/11, and judgment of 17 December 2014, Case No. I R 23/13.
24 Judgment of 24 June 2015, Case No. I R 29/14.
25 Judgment of 24 August 2011, Case No. I R 46/10.
26 Case No. I R 27/11.