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It is a common error to regard procedural law as a dull subject. An even greater error, however, is to view it as an unimportant one. This article explains tax litigation in Germany in the context of German procedural law and explores alternative methods of dispute resolution outside of the litigation framework.
1. Basic statutory procedural framework
The German Tax Procedure Act permits direct enforcement of tax assessment notices by the tax authorities against the taxpayer. Before initiation of collection procedures, administrative or judicial, the following prerequisites must be met:
- Tax must be timely assessed (generally, written assessment notice);
- Notice of the assessment must be given to the taxpayer;
- Demand for payment (generally part of the assessment notice) must be made; and
- The payment period stated in the demand for payment (generally one month from when notice is given) must expire without the tax having been paid.
As a rule, the tax authorities also give one week's written notice of their intent to institute involuntary collection procedures.
Germany's use of self-assessed taxes is limited primarily to VAT and withholding taxes, including payroll withholding. Most other taxes are assessed by written notice given by the tax authorities to the taxpayer. This applies to all taxes on income including advance payments on estimated future tax liability.
Notice of assessment is thus generally given by delivery of the assessment notice to the taxpayer. If delivery is by domestic mail, the notice is deemed received on the third day following posting unless actually received at a later date. In case of doubt, the tax authorities must prove the fact and time of actual receipt.
Having received an assessment notice, the taxpayer has the following options to avoid collection measures:
- Pay the tax by the due date;
- Obtain a deferral from the tax authorities; or
- File an administrative appeal against the assessment.
The third option is the most important one. It does not automatically avoid collection measures, however. To accomplish this, the taxpayer needs to request a stay of collection in addition to contesting the merits of the assessment. The tax authorities must grant the request if the validity of the assessment is subject to "serious doubt". If they reject the request, the taxpayer can take the issue to the Tax Court.
The Tax Court is the trial level court in a two-tier court system with subject matter jurisdiction only in the area of taxation. The decision of a Tax Court may be appealed to the Federal Tax Court, the appellate court in this system. The Federal Tax Court reviews the lower court's decision only for error of law.
German national tax law is subordinate to German constitutional law and to applicable European law. Any German court convinced of the unconstitutionality of a legal provision relevant to the outcome of a case before it must suspend proceedings and certify the question to the German Federal Constitutional Court, a high court with jurisdiction only in constitutional matters. With respect to European law, lower courts such as the Tax Court have the option of certifying relevant doubtful questions to the European Court of Justice. High courts such as the Federal Tax Court are obligated to so certify when there is serious doubt whether German law is compatible with European law or is being construed in accordance with European law. After a decision by the Federal Constitutional Court or the European Court of Justice, as the case may be, the case returns to the certifying court for ultimate disposition.
After exhausting his remedies in the tax court system, a taxpayer may himself appeal on constitutional grounds to the Federal Constitutional Court. The appeal is available in situations where the Tax Court and/or Federal Tax Court have refused to certify to the Federal Constitutional Court. The Federal Constitutional Court will only hear the appeal, however, if it meets certain requirements.
In situations posing issues of international double taxation, relief may be available even from a final decision of the Federal Tax Court through either an arbitration proceeding pursuant to the EU Transfer Pricing Arbitration Convention or through a mutual agreement proceeding pursuant to an applicable tax treaty. The EU Transfer Pricing Arbitration Convention is currently due to expire at the end of 1999. Its extension appears probable, but it is currently unclear whether extension requires new acts of ratification by the Member States or may be accomplished by resolution by the Council of Ministers. Even if the convention is extended, this may not occur until after the end of 1999. If extension occurs after the end of 1999 and is not retroactive, this would result in an interim period during which the convention will not apply.
The sections which follow focus on the key phases of tax litigation: the administrative appeal and court litigation at the trial and appellate levels.
2. Administrative appeal to the tax authorities
The purpose of the administrative appeal is to afford the tax authorities the opportunity of reconsidering the correctness of their assessment and allow them to discuss the factual as well as legal aspects of the case with the taxpayer.
The administrative appeals phase begins with an appeal filed by the taxpayer against a decision by the tax authorities, typically one issued in the form of an assessment notice. Appeals may also be filed against other types of administrative action, however.
The taxpayer generally has one month from the time of notification of the administrative action in which to file an appeal. The appeal can be filed either by the taxpayer himself or by his authorised representative.
The administrative appeals process is free of charge. Neither side is entitled to reimbursement for its costs and expenses.
If the taxpayer so requests, the tax authorities are generally required to meet with the taxpayer for a face-to-face discussion of the relevant factual and legal situation. The tax authorities can also on their own initiative request the taxpayer to attend such a meeting. Such meetings are intended to move the proceeding forward as expeditiously as possible. As a rule, it is in the taxpayer's interest to request a meeting at an early stage. The principal contested issues can often be resolved or at least clarified in the course of such a meeting. It is generally a good idea to request a meeting at the same time the appeal is filed.
The administrative appeals proceeding can take several months, depending on the complexity of the legal and factual issues. It is generally dominated by the tax authorities. Only if the parties fail to reach agreement will the tax authorities issue a formal appeals decision notice. An appeal to the Tax Court can be taken against such a notice. The appeal must be filed with the court within one month.
Interesting procedural rules govern the extent to which the tax authorities may vary the content of the contested administrative action to the taxpayer's detriment. German procedural law permits this provided the tax authorities first notify the taxpayer of their intention. For instance, the tax authorities can issue an appeals decision which increases the original assessment of tax, but only after notifying the taxpayer of their intent and giving him opportunity to respond. Since the taxpayer can always respond by withdrawing the appeal and ending the proceeding, he is in effect able to ensure that he is not worse off after the administrative appeal than he was before. Of course, by withdrawing the appeal the taxpayer surrenders his right to judicial review.
The tax authorities may set a reasonable deadline (generally one month) for the taxpayer to provide facts and evidence supporting positions he has taken. If the taxpayer fails to meet the deadline, the tax authorities may disregard facts and evidence subsequently provided.
The exclusion of facts and evidence at the administrative appeals level does not necessarily mean they will be inadmissible in a later court proceeding. The Tax Court instead uses its own judgement in deciding whether to ignore the taxpayer's belated pleadings. A risk of the Tax Court's disallowing the late pleadings exists, however, when it would delay the trial to let them in and there is not sufficient excuse for the lateness. It is therefore advisable for the taxpayer to produce all facts and evidence favouring his case in timely fashion.
The mere fact of filing an appeal does not avoid the obligation to pay assessed tax or prevent the tax authorities from taking steps to enforce collection if timely payment is not forthcoming. Failure to make timely payment will result in the assessment of additional late payment penalties, which in principle remain valid and owing even if the taxpayer later prevails on the merits.
The basic obligation to make payment is only suspended if the taxpayer files a request for a stay of collection and the tax authorities grant the request.
The tax authorities are in general required to grant a motion for a stay if, based on a summary review, serious doubt exists as to the validity of the contested administrative action or if the execution of the legal action would result in unfair or inequitable hardship for the person affected which is not outweighed by an overriding public interest.
If the tax authorities reject the taxpayer's request for a stay of collection, the taxpayer may file an appeal with the tax authorities against this rejection. It is generally more expedient, however, to file a new request for a stay of collection directly with the Tax Court. A new request can be filed immediately with the Tax Court even though an appeal on the merits to the Tax Court would be premature because the administrative appeal is still pending.
A decision by the Tax Court on the issue of a stay can have de facto precedential effect on the administrative appeal which is still pending. Although the Tax Court reviews the questions of law and fact in summary fashion in an expedited proceeding, the court's decision on the question of a stay often reveals how it might rule on the merits. A decision by the court in the taxpayer's favour not infrequently facilitates reaching an agreement with the tax authorities at the administrative appeal level.
If the tax authorities reject the taxpayer's request for a stay and there is reason to fear that the Tax Court will not be able to rule on a new request filed with it before payment of tax is due, it is generally in the taxpayer's interest to file an immediate request with the tax authorities to defer the tax payment.
There are effective remedies available to the taxpayer in the event of inaction on the part of the tax authorities. If the tax authorities fail to decide an appeal within a reasonable period, as a rule six months, the taxpayer may file suit with the appropriate Tax Court by reason of their inaction without awaiting an appeals decision notice.
If the taxpayer is seeking some action in his favour outside of the administrative appeals process (for instance, the grant of a tax subsidy, the recognition of some favoured tax status, or the issue of an exemption certificate), the tax authorities are required to decide on the request within a reasonable period. If they fail to do so, the taxpayer may file a motion with the tax authorities to initiate formal review of their inaction. This procedure is generally effective.
If taxpayer is seeking neither to quash an administrative action to his detriment nor to have an administrative act issued to his benefit (examples: action to preserve an existing state of affairs or to deal with a temporary condition), he must file a request for a temporary injunction directly with the Tax Court. A temporary injunction can have significance in particular in connection with an administrative collection procedure.
In the event the taxpayer has failed to meet a legal deadline, for instance, failed to file an appeal within the one month appeals period, he can file a request to be returned to the status quo ante. Such a request must be granted if the taxpayer can show that he was prevented from meeting the deadline through no fault of his own (obstacle to filing).
The request must be filed within a month after removal of the obstacle to filing. The taxpayer must likewise file the appeal in a proper manner within this deadline.
There are special circumstances in which the aforementioned one month appeals period is not relevant. For instance, this is the case if a tax assessment notice has been issued by the tax authorities subject to later audit or if the tax assessment was provisional only. In such cases, it is generally sufficient for the taxpayer to file a request to amend or vacate the relevant assessment notice. If the tax authorities reject such a request, the taxpayer must, however, here again file an appeal within a one month deadline.
Finally, for reasons of procedural economy, there are situations in which it is may be advisable for the taxpayer to file requests for a stay of collection and for suspension of proceedings with the tax authorities. Such a request is advisable when the taxpayer is basing his appeal on a case which is pending before the European Court of Justice, the Federal Constitutional Court, or one of the high national courts (such as the Federal Court of Justice) and which involves an issue relevant to the outcome of the administrative proceeding. Once the court has ruled in the parallel proceeding, the administrative appeal can go forward with account being taken of the result reached in the parallel case.
3. Tax litigation
3.1 Trial level: the Tax Court
Strict formal requirements and filing deadlines must be observed when filing suit with the Tax Court. Errors in these respects can result in dismissal of the suit on formal grounds. The operating report of the German Tax Courts for the years 1997 and 1998 shows that approximately 32 % of all suits filed with Tax Courts in these years were dismissed on formal grounds.
While there is no general requirement that the plaintiff be represented by an attorney or a chartered tax consultant before the Tax Court, the formalities involved make it advisable to have the suit prepared by qualified counsel.
The basic filing period is one month from the time the taxpayer was notified of the formal decision on his administrative appeal. The judicial appeal takes the form of a complaint brought by the taxpayer as plaintiff against the tax authorities as defendant before the Tax Court of proper jurisdiction.
The appeal is generally filed in writing with the Tax Court. However, the appeal may also be filed with the tax authorities who issued the administrative decision. The tax authorities are in this case required to transmit the complaint to the appropriate Tax Court without delay. If the complaint is filed with the tax authorities, it is vital that it be sent to the proper authority. Should the complaint be filed with the wrong office, the timeliness of filing depends not on the date of receipt by the tax authorities, but rather on the date when the complaint is actually received by the Tax Court. A delay in forwarding the complaint is then fatal to the suit.
It is therefore advisable to file the appeal with the court, not the tax authorities.
If the taxpayer has failed to file the judicial appeal within the one month filing period, he can in principle file a request with the Tax Court for return to the status quo ante on the same grounds as such motions are entertainable in the administrative appeals proceeding. However, in the judicial proceeding the request must be made within two weeks after removal of the obstacle to filing. Furthermore, all facts on which the request is based must likewise be communicated to the court within this deadline.
The Tax Court is in principle required to determine the facts relevant to the disposition of the case ex officio, that is, on its own initiative. However, the parties have an obligation to co-operate in the fact-finding process. This applies particularly to the plaintiff. Failure to comply can, for example, result in refusal by the court to consider factual circumstances beneficial to the plaintiff, but not timely raised.
The Tax Court is the only judicial level at which factual pleadings are admissible and findings of fact are made. The factual findings of the Tax Court are not reviewed at the appellate level and are hence binding. It is therefore critical to raise all facts and offer all evidence favourable to the plaintiff at the trial level.
The judicial appeals proceeding differs from the administrative appeal in that the Tax Court is not permitted in its judgement to modify the tax authorities' administrative decision to the taxpayer's detriment, even if it believes this is warranted as a matter of substantive law (so called prohibition of reformatio in peius).
The Tax Court is organised into chambers. A case is typically heard and decided by a chamber of three professional judges and two laymen serving as honorary judges. Under certain circumstances, the case may be heard by a single professional judge sitting alone. It is generally in the taxpayer's interest to avoid having his case heard by a single judge as then the decision is naturally more subjective than would be that of the full chamber.
Instead of holding a hearing, the Tax Court may decide the case on the basis of the written pleadings. In this event, the act by which it decides the case is referred to as a court pronouncement (Gerichtsbescheid). After receiving the court pronouncement, the parties have one month to request the court to set a date for oral argument. In this case, the court pronouncement never takes effect. The court's disposition of the case after hearing oral argument is referred to as a judgement (Urteil). If the matter before the court is a motion or request, e.g. a request for a stay of collection of tax, the act disposing of the case is called a ruling (Beschluß). In this article, the term "decision" includes both judgements and rulings.
Currently, the average duration of a proceeding before the Tax Courts is roughly 29 months. The prevailing party has a right to recover costs and expenses (pro rated to the extent of its success when this is not total). However, reimbursement is determined with respect to a statutory schedule of fees and costs and typically falls short of actual expenditure.
3.2 Appellate level: Federal Tax Court
Decisions of the Tax Court may be appealed by either party within one month after they are served on the parties. The appeal is referred to as Revision if taken from a judgement by the Tax Court and as Beschwerde if taken against a ruling. It is filed with the Federal Tax Court, which is the highest court in the tax court system.
The taxpayer must be represented by an attorney (Rechtsanwalt), a chartered tax consultant (Steuerberater), or a chartered accountant (Wirtschaftsprüfer) in appeals proceedings before the Federal Tax Court. The appellate level differs from the trial level in this respect. Costs and expenses are awarded in accordance with the statutory schedule and the degree to which a party has prevailed. Once again, strict formal requirements and filing deadlines apply. Failure to comply with these can result in dismissal on formal grounds without decision on the merits by the Federal Tax Court.
The one month deadline for appealing to the Federal Tax Court runs from the date of service of the complete decision rendered by the Tax Court. The appeal can be filed without a statement of grounds, but in this case the statement of grounds must be submitted within the month to follow. An extension can be granted for filing the statement of grounds, but not for filing the appeal itself. A motion for return to the status quo ante is the only remedy if the appeals filing deadline has been missed.
The appeal may only be filed with the Tax Court which rendered the decision appealed from.
The taxpayer has no automatic right to appeal the judgements of the Tax Court. Such appeals must be authorised by the Tax Court in the judgement itself. If the Tax Court fails to authorise an appeal, the party wishing to appeal may file a petition with the Tax Court to allow the appeal. Such a petition is called a Nichtzulassungsbeschwerde or complaint of disallowance of appeal. The petition is ruled on by the Federal Tax Court.
Appeal from a judgement of the Tax Court is authorised only if one of the following apply:
- the matter has fundamental legal importance;
- the judgement is at variance with a decision of the Federal Tax Court or the Federal Court of Justice and rests on this variance; or
- if the outcome may have been affected by procedural error.
In practice, fundamental legal importance is the alternative under which most appeals qualify. A direct appeal to the Federal Tax Court (without petition for grant of the right to appeal) is also possible, but only on grounds of grave procedural error as defined by statute. This situation seldom arises, however.
The above standards apply both for the Tax Court's decision to allow or disallow an appeal and, in the case of disallowance, for review thereof by the Federal Tax Court pursuant to petition from a party desiring to bring an appeal.
An estimated 7 % of all Tax Court judgements were appealed pursuant to permission granted by the Tax Court in the years 1997 and 1998. Petitions for permission to appeal were filed for another 10 % of such judgements. Of the appeals filed, roughly 24 % were dismissed on procedural grounds and another 27 % on the merits. Of the petitions to allow appeal, approximately 45 % of these were dismissed on procedural grounds and another 35 % on the merits.
It has already been mentioned that the Federal Tax Court reviews the trial court's decisions for errors of law only. Hence, the factual record at the trial court level is the basis on which the Federal Tax Court hears an appeal.
The act by which the Federal Tax Court decides cases, either after oral argument or without oral argument, but with the consent of the parties, is called a judgement (Urteil). The court can also decide by ruling (Beschluß) without oral argument and without the consent of the parties. It need not state the grounds of such a ruling. Such decision by ruling is only permissible if the entire chamber hearing the case, which means five professional judges, unanimously regards the appeal as without merit. The court can also decide by court pronouncement (Gerichtsbescheid) in the absence of oral argument, but the acceptance of such a decision is optional for the parties.
The average duration of an appeals proceeding on which the court renders a full decision with statement of grounds is presently around 20.5 months. In 1989, it was as long as 40 months. The entire judicial review process at the trial and appellate levels can thus presently take more than four years.
In light of the length of time which litigation can consume, it frequently makes economic sense for the taxpayer to seek an out-of-court resolution of his dispute with the tax authorities. The balance of this article explores the possibilities available here.
4. Alternate methods of dispute resolution
4.1 Factual agreement
German tax law does not permit the parties to a tax dispute to enter into a binding settlement agreement. However, the Federal Tax Court has consistently held that a binding "factual agreement" (tatsächliche Verständigung) is permissible. In its 1984 leading decision, the court stated that the tax authorities and the taxpayer could enter into an enforceable agreement with regard to the factual circumstances to which the tax laws were to be applied, even though they could not conclude any agreement with binding effect as to the legal consequences flowing from these facts.
The court established an important requirement for a factual agreement in the above sense. To be binding, the court said that it was not enough for the factual agreement to be entered into merely between the German tax auditor and the taxpayer, e.g. in the context of an end-of-audit conference. In addition, the court stated that direct participation and agreement by the tax official actually responsible for assessment of tax (the tax assessment officer) was also necessary. Consent after the fact by the assessment officer was insufficient in the court's view. Furthermore, the court sanctioned only retrospective factual agreements relating to events completed in the past, not prospective agreements as to facts not yet transpired.
Of course, the parties may at any time reach a non-binding understanding as to what they will and will not accept, but such an understanding is not enforceable. Non-binding understandings generally relate to the actions the parties will and will not take (e.g. the amount of tax the tax authorities will assess and the sort of assessment the taxpayer will not contest) and hence can extend to the actual application of laws. Their major drawback is that they rest only on mutual trust.
Factual agreements, however, are of great importance to both the taxpayer and the tax authorities. Particularly in the tax audit context, experience shows that potential disputes can often be avoided by means of factual agreements, assuming a certain degree of negotiating skill and economically well-founded argumentation on the part of tax counsel and participation by the tax assessment officer.
In the context of administrative appeals, German procedural law has since 1996 also permitted the parties to meet face-to-face to discuss their differences. Experience shows that such meetings sometimes result in quick resolution of at least some of the disputed matters by means of a factual agreement.
4.2 Advance rulings
Statutory authority exists for binding advance rulings by the tax authorities (private letter rulings) only in the tax audit context. Such rulings may be requested by the taxpayer immediately following an audit, for instance, in order to insure that the tax authorities will in the future adhere to the same position taken in the context of the present audit with respect to some doubtful issue.
However, both the courts and the tax authorities have recognised that the basic principle of good faith dealing permits the tax authorities to issue advance rulings to the taxpayer upon request in other situations not covered by the statute. The essential advantage of such rulings for the taxpayer is that they commit the tax authorities with regard to the tax consequences which will attach to future actions by the taxpayer. This provides the taxpayer with a basis for tax planning purposes and at the same time avoids possible litigation with regard to these actions.
The Federal Tax Court has stated that advance rulings are available in principle if the following three conditions are met:
- the set of facts to which they relate must not yet have transpired;
- the tax authorities must have a certain degree of discretion with respect to their handling of the set of facts; and
- the taxpayer must have an economic interest in receiving the advance ruling.
An advance ruling is only binding under the principle of good faith dealing if the set of facts which arises subsequent to issuance of the ruling is identical to that which was assumed for purposes of issuing the ruling. The ruling also lapses if the laws on which it is based subsequently change.
The tax authorities generally refuse to issue rulings when the situation to which they relate is one which the taxpayer is interested in bringing about only or primarily in order to derive tax benefits. There is virtually no chance of securing a ruling on situations which the tax authorities regard as abuses of the legally permissible tax structuring possibilities. The tax authorities also decline to issue advance rulings with respect to matters as to which a high court decision or a statutory or regulatory ruling are anticipated in the foreseeable future.
5. Concluding Remarks
Considering the length of time required for court resolution of a tax dispute, the procedural pitfalls which pockmark the litigation path, and the expense which litigation can entail, the tax authorities as well as the taxpayer often have every interest in resolving their differences out of court. The measure of economic success which the taxpayer enjoys in his attempts to reach satisfactory results while avoiding slow and costly litigation will finally depend of the negotiating skill and creativity which tax counsel brings to bear on the tax problems which present themselves.
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