Commencing disputesi 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. Statute provides for such declaratory notices of assessment in numerous situations. One such group are cross-border scenarios: for example, those involving the German controlled foreign company rules, also referred to as add-back taxation. 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. 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. 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. 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. 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. The complaint needs to be filed and substantiated within one month of the complainant being notified of the final judicial decision. 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; or that the courts violated the right to a hearing enshrined in the Constitution.
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. 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. 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.