Do you really know which tax structuring measures are permissible and at what point they become tax fraud? Are there any precise regulations regarding this, or is much of it left to the discretion of the tax officials?
Are you uncertain about these questions and have therefore been reluctant to introduce tax structuring measures?
I can certainly understand that.
For you as an entrepreneur, these laws and regulations are probably obscured by an indecipherable web of legalese.
You probably don’t have time to unravel the mystery and think you’ll never get to grips with it.
This is exactly where I would like to start with this post: I will explain everything you as an entrepreneur need to know about tax fraud and how to avoid it in an easy-to-understand way using practical examples.
In less than ten minutes you will learn:
- Where tax fraud starts
- What legal penalties you may face
- How business owners often commit tax fraud unintentionally [including case study]
- Two systems you can use to protect your company
This post was updated on 27 July 2021.
Strictly speaking, any incorrect balance sheet entry is already classed as tax fraud. In criminal tax law, there is no clear line here. Any unjustified tax advantage is seen as tax evasion.
In practice, however, this principle is not so strictly applied. If an error is discovered during a tax audit, an incorrect balance sheet entry is often simply corrected.
That is, you receive a new tax assessment and simply make an additional payment. This would normally settle the case and there would be no criminal proceedings.
The situation is different if you deliberately abuse tax structuring methods (pursuant to Section 42 German Fiscal Code (AO)). Unfortunately, in Germany one cannot generalize about exactly which tax structuring measures are classed as fraud and which not.
Here it always depends on the individual case in question how the investigating officials judge the particular tax structuring methods used. I will explain below how this could look in practice with an easy to understand case study.
In the case of cross-border structuring, however, new laws (Sections 138a – 138k AO) were passed on January 1, 2020 and “popular” structuring measures were specifically named.
Cross-border structuring measures, such as the “shifting” of profits to low-tax countries, must now be reported to the tax office. The tax officials then decide whether the measures are permissible or indeed constitute tax fraud.
Depending on how successful these new laws are, it is quite possible that a reporting requirement for domestic tax structuring will also be introduced in the future.
As a managing director, you are legally obliged to conduct all business “with the care of a prudent businessperson” (Section 43 German Limited Liability Companies Act (GmbHG)).
In other words: If you violate your duty of care, you are personally liable for possible damages and even if you are “only” an employed managing director, the GmbH can claim compensation from you.
Which penalties you face depends primarily on the exact facts of the case. Among other things, two scenarios are possible here:
Scenario 1: Tax evasion
If investigations are initiated against you on suspicion of fraud, the tax office will always first assume that tax evasion has been carried out. This is because, as explained above, every incorrect balance sheet entry is initially classed as attempted tax evasion.
If you do not pay your taxes in full or pay them too late, you are also committing tax evasion.
If the accusations are substantiated and you are unable to produce information that exonerates you, a conviction is very often the result in practice.
Possible penalties for tax evasion: Fines of up to €50,000. In the case of serious evasion, you can be sent to prison for up to 10 years.
Scenario 2: Understatement of tax
Understating taxes is a more minor form of tax evasion. If it turns out in the investigation that you were only slightly negligent, then you can be only convicted of understatement of tax (Section 378 German Fiscal Code (AO)).
Some more good news: Understatement of tax is “only” an administrative offense and not a criminal offense. While you will most likely have to pay a fine, the judgement will not be recorded in your criminal record.
Possible penalties for understating taxes: Fines of up to €50,000.
Too fast and too much: This is how companies often unintentionally commit tax fraud (with a case study)
Basically, tax structuring is always a balancing act. Ideally, you take advantage of legal grey zones without crossing the line into illegality. Therefore, one must proceed with great caution here.
In my opinion, this is precisely where the most common mistake in tax structuring occurs: Many entrepreneurs simply structure their tax using far too many different measures far too quickly.
Then the tax office assumes that you have a so-called “overall plan”. Here it is assumed that the individual structuring measures were taken as part of an overall plan for tax savings.
The best way to explain this “overall plan” ruling is by means of a practical case study:
Assume you are a sole proprietor and would like to convert your business into a GmbH & Co. KG.
As a sole proprietor, you own commercial real estate and upon termination of your sole proprietorship, these buildings would be taxed as hidden reserves.
To avoid this taxation, you transfer your commercial real estate to your new GmbH & Co. KG.
Then you close your sole proprietorship and have avoided the taxation of the hidden reserves.
You do all this in a period of a few months.
Due to the swift succession of many measures (transfer of the real estate, closing of the sole proprietorship, etc.) within this short period of time, the legislator will almost certainly rule that there was an overall plan here.
Then you will be in for criminal tax proceedings.
In order for this not to be seen as an overall plan, the structuring measures in this case would probably have to be spread over a two-year period.
As a rule of thumb with regard to the “overall plan”, please remember the following: The higher the amount of tax you save as a result of the measures, the longer the individual steps must be spaced out over time.
Internal control system and Tax CMS: how to protect yourself and your company from criminal proceedings
As explained above, you make yourself liable for prosecution by abusing structuring measures.
However, there is one exception here: If you have an Internal Control System (ICS for short) or a Tax CMS, you can make tax adjustments without criminal proceedings.
This security is a great incentive for companies to implement these systems.
Because the advantage is obvious: If your structuring measures violate the law, with a Tax CMS or ICS you will probably get away with a simple back tax payment.
Without control systems, on the other hand, you will have criminal proceedings on your hands. If convicted, you will face heavy fines and, in the worst case, even a jail sentence.
My recommendation: If you want to protect yourself and your company in the best possible way, you definitely need an ICS or a Tax CMS in your company.
Conclusion: Digital control systems reduce your risk of tax fraud
You need a lot of expertise, experience and intuition for proper tax structuring. If you proceed carelessly, you will quickly commit criminal tax fraud.
It is especially important that you do not implement too many structuring measures in too short a time. Because then the legislator will rule that you had an illegal overall plan and you will be faced with criminal proceedings.
As well as carefully planning your structuring measures, you should introduce an Internal Control System (ICS) or a Tax CMS in your company. Because once your structuring measures are actually deemed to be an abuse of the system, control systems will probably help you get away with just paying back taxes.
Otherwise, you will be prosecuted.
Finally, I would like to leave you with the following: Never carry out tax structuring measures by yourself. Always bring an experienced tax consultant on board.
Because only an experienced tax consultant knows which measures are really suitable for your company and what to look out for when implementing them.
If you have any further questions about tax structuring measures, or if you would like to introduce control systems into your company, I would be happy to advise you.
You can contact me any time via my contact form.
Among other things, I specialize in the implementation of Tax CMS and Internal Control Systems and will be happy to help you with them.
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