Deloitte Survey: Government Tax Audit – Stress Test

Larger enterprises face a greater risk of additional taxes after a German tax audit

This is one result of Deloitte's recent "Tax Audit Stress Test" survey. The survey also shows interesting results regarding additional taxes in relation to the size of a company’s tax departments, as well as the atmosphere during an audit. According to the survey, the acceptance of provision expenses, the valuation of fixed assets and constructive dividends are the top issues in the years under audit. In a cross-border context, the most frequent issue is failure to comply in whole or in part with the documentation rules relating to related party transactions.

Almost all German taxpayers (including commercial businesses, self-employed persons, agricultural and forestry businesses, certain types of investment partnerships and others) are subject to tax audits at the hands of the German tax authorities. Taxpayers subject to audit face not only the extra costs and labor entailed in responding to the enquiries of the tax auditor, but also potential liability for additional tax and interest claims assessed in the tax audit. 

According to the official statistics published by the tax authorities of the Federal States, tax audits performed in 2010 resulted in additional tax revenue claims amounting to 16.8 billion Euro. While this figure includes the additional tax revenue resulting from audits of all taxpayers generally subject to tax audits (i.e. commercial enterprises, self-employed persons, agricultural and forestry businesses, etc.), it does not include the additional tax revenue resulting from wage tax audits, special VAT audits or tax fraud investigations. 

Tax audits of enterprises defined as “large enterprises” under the German procedural rules account for the largest part of the additional tax revenue (71 %). This figure has prompted Deloitte to conduct an online survey of large enterprises (i.e. enterprises deriving revenues in excess of 10 million Euro and/or with more than 250 employees), which seeks background information on the additional tax revenue assessed. Representatives from 733 companies participated in the survey.

Survey results

One group of questions, which focused on identifying the years under audit, revealed that audits concerning income taxes (including transfer pricing) and VAT were currently mainly being conducted for the years 2005 to 2009, whereas wage tax audits were mainly conducted for the years 2008 to 2010. Thus, while wage tax audits are performed in a relatively timely manner, audits concerning the other types of taxes are conducted, on average, five years after the period to which they relate. This delay represents a major burden particularly for taxpayers that have reorganized their group structure or have implemented new IT architecture for their financial reporting/bookkeeping in the interim.

Other questions focused on the general atmosphere of the relationship between the companies concerned and their tax auditors. The majority of the companies surveyed described this atmosphere as “pleasant” or “objective/ neutral,” only one in 10 participants reporting a tense, and one in a 100 a hostile, atmosphere. The majority of those companies reporting a tense or hostile atmosphere considered themselves subject to significant additional tax claims. 

The survey paid particular attention to the amount of additional tax expenses resulting from the tax audit. Additional tax expenses were first measured against the original tax claim prior to the audit to ensure the comparability of the figures. Additional tax claims were then divided according to the type of tax. While only a few of the companies surveyed faced significant additional tax claims with respect to wage tax and VAT, the situation was very different with regard to income tax, including transfer pricing. Additional tax expenses resulting from transfer pricing adjustments correlated very closely with the location of the company headquarters.

In relation to certain types of taxes, the survey suggested that the larger the company and the size of its tax department, the higher the proportionate additional tax expenses. This may be attributable simply to the fact that larger companies tend to come up against more complex tax issues. At the same time, it seems that larger tax departments are able to avoid exceptional peaks in additional tax payments, which may indicate that companies with larger tax departments tend to devote their resources to higher-risk tax issues.

The most common issues regarding general income taxes related to the acceptance of provision expenses, the valuation of fixed assets and constructive dividends. In relation to transfer pricing, companies with nonresident parent companies were most frequently confronted with concerns regarding non-compliant or missing documentation of dealings with related parties. In relation to trade tax, the trade tax addbacks (according to which a portion of certain types of expenses is nondeductible) appear to be the main area of concern. Company events and benefits in kind (identification and taxation) constitute the main issues raised in wage tax audits. In the area of VAT, the main reasons for additional tax payments are incorrect allocations of input VAT, and the lack of supporting evidence in the books of accounts and vouchers for EU and third country supplies.

Deloitte Survey