We would like to inform you about an interesting judgment of the Supreme Administrative Court (SAC) No. 2 Afs 170/2023 – 30 of 24 October 2023.

The Supreme Administrative Court addressed the question of whether the conditions for conducting a tax audit, which was preceded by extensive search activities of the administrator, were met. We discussed the situation, when the tax administrator’s search activity exceeds its limits, thus effectively constituting a tax audit, and what procedural consequences such an intention may have, in detail in our article of 17 May 2022, which can be found under this link.[1]

In the present case, the tax administrator carried out an extensive search activity, in the course of which it examined the facts relating to crown bonds issued in 2012. Subsequently, in 2021, it initiated a corporate income tax (CIT) audit for the tax period from 1 January 2014 to 31 December 2015, limited to an examination of transactions related to the issue of crown bonds and an examination of transactions related to the purchase of a business share. From the very beginning of the audit, the tax entity argued that the scope of the examination of transactions related to the bond issue was in fact a repeated and therefore illegal tax audit. Since the tax administrator assumed that the audit was not a repeat audited, the reasons justifying the possibility of conducting a repeated audit pursuant to Section 85a(2) of the Code of Tax Procedures were not stated in the protocol on the initiation of the audit.

In the case at hand, the Municipal Court in Prague agreed with the taxpayer that the tax administrator was conducting repeated tax audits in the scope of transactions related to the bond issue. The local inquiry conducted by the tax administrator in 2017 went beyond the limits of a search activity and was a disguised tax audit. In view of the distance between the completion of the search activity associated with the local inquiry and the subsequent formal initiation of the tax audit, this is a repeated tax audit. However, in the opinion of the Municipal Court, the legal conditions for its repetition were met. During the oral hearing, the Municipal Court took evidence of documents from the search (non-public) part of the file, including information from the Financial Analysis Office (FAO) dated 9 July 2019, on the basis of which it concluded that the tax administrator had discovered new facts from the FAO that were capable of raising doubts within the meaning of Section 85a(1)(a) of the Code of Tax Procedures. According to the municipal court, the repeated tax audit was not an unlawful intervention.

The SAC, however, did not agree with this conclusion of the municipal court. First of all, it confirmed that the case law on the issue of search activities, which in fact had the character of a tax audit, had gradually developed, referring to the judgment of 6 February 2023, no. 5 Afs 287/2021-32, in which the Supreme Administrative Court succinctly explained the purpose of these case law conclusions as follows:

“The cited case law was originally created primarily to protect the rights of tax entities against the procedure of a tax administrator who would actually carry out a tax audit under the guise of a local inquiry, but during which the audited tax subject would not be provided with the level of protection of his rights that the law associates with a formally initiated tax audit, or where the tax administrator would circumvent the statutory provisions governing tax audit even by assessing tax directly on the basis of a local inquiry (see judgments of the Supreme Administrative Court of 27 April 2005, No. 1 Afs 70/2004-80 and 1 Afs 60/2005-130 of 26 April 2006). At the same time, however, the conclusions reached by the Supreme Administrative Court, in particular in the last cited case, are undoubtedly intended to protect also against such a procedure of the tax administrator, which by the very act formally declared as a local inquiry, although in fact corresponding in nature to a tax audit, would not immediately result in the assessment of tax deviating from the submitted tax return or in its assessment, but would subsequently return to the examination of the same facts in the form of a tax audit, without complying with the conditions laid down by law for the initiation of a repeated tax audit.”

Thus, although it may have been surprising to the tax administrator that the formally first tax audit was in fact a repeated tax audit, because the case law on the matter was not yet fully settled at the time that he initiated the audit, the underlying problem lay in the unlawful conduct of the tax administrator himself. According to the nemo turpitudinem suam allegare potest principle, no one can benefit from his own dishonesty or, in a broader sense, from his own misconduct. The tax administrator erred in failing to disclose to the taxpayer the reasons for initiating a repeated tax audit pursuant to Section 85a(2) of the Code of Tax Procedures, as a result of which the repeat tax audit was initiated in conflict with the law.

The Supreme Administrative Court in point [22] of the judgment in question stated that the obligation of the tax administrator to inform the tax subject of the reasons for the repeated tax audit cannot be regarded as a mere formal requirement, the lack of which could not affect the rights of the tax subject, since the communication of the reasons for the repeated tax audit already at the commencement of the tax audit:

• allows the tax subject to make a judgement as to whether the conditions for repeating an audit are met, or to defend against the implementation of a repeated audit in court (therefore, the tax subject must have all the necessary information before filing a lawsuit against an unlawful intervention, and cannot be forced to file a lawsuit “blindly”);
• allows the taxpayer to supervise the further course of the tax audit and additional assessment proceedings in the sense of whether they do not go beyond the permissible framework of repeating the tax audit;
• ensures the transparency of a repeated tax audit, as it firstly proves that the tax administrator was aware of specific new facts prior to the commencement of the repeated tax audit and secondly prevents the expansion of the range of new facts after the commencement of the tax audit, which is essential for the course of the tax audit, but also for the scope of the audit findings.

The SAC also examined the very reasons for conducting a repeated tax audit, which were the basis for the municipal court’s contested judgment. According to the information from the FAO, these involved questions about the origin and taxation of funds from one of the subscribers of the 2018 and 2019 crown Bonds. The SAC concluded that there was no connection between these facts and the tax period under review. The SAC stated that the connection of the new facts to the tax period under review and the specific transactions cannot be merely hypothetical, but must be substantiated to the extent that it creates reasonable doubt as to the correctness, conclusiveness or completeness of the tax or the taxpayer’s assertions to date. In the present case, however, there were no documents in the file to prove and substantiate this connection and the tax administrator did not further explain this fact in the court proceedings.

Overall, the SAC concluded that in the case at hand, the tax administrator did not prove that the conditions for the possibility of initiating a repeated tax audit under Section 85a(1)(a) of the Code of Tax Procedures were met.

[1] For the sake of completeness, in connection with the article published on 17 May 2022, we add the result of our client’s litigation, where the Supreme Administrative Court found the time interval of approximately 3.5 months between the last act of the tax administrator and the initiation of a tax audit to be sufficient to constitute an unlawful repeated tax audit. 

Author: Lenka Kočerová, Jaroslava Půtov