Within its statutory activities, the tax administrator is entitled to perform search activities, where it searches for evidence and tax subjects and ascertains the fulfilment of their obligations in tax administration before commencing a proceeding and in the course of it. As part of the search activity, the tax administrator may carry out a local inquiry, during which the tax administrator searches in particular for evidence and conducts inspections of tax subjects and other persons involved in tax administration, as well as at the place, where it is most appropriate for the purpose of the local inquiry. The taxpayer and other persons present are obliged to provide the official conducting the local inquiry with all reasonable means and necessary cooperation to carry out the local inquiry effectively.

It is not uncommon for tax administrators to use local inquiry to request a number of documents and statements from tax subjects, which they then analyse for several months and subsequently initiate a tax audit. The Supreme Administrative Court has repeatedly commented on when this procedure of the tax administrator exceeds the scope of a mere search activity and in fact constitutes a tax inspection. 

Local inquiry vs. tax audit

According to the constant case law of the Supreme Administrative Court, there is a significant difference between these two concepts and the tax administrator is not entitled to choose between them without limitation.

In the judgment of 1 March 2022, No. 7 Afs 231/2021 – 31 (preceded by the judgment of 2 July 2020, No. 7 Afs 390/2019 – 44 in the same case), the Supreme Administrative Court summarized the conclusions of the previous judgments of 27 July 2005, No. 1 Afs 70/2004 – 80, No. 937/2006 Coll. of the Supreme Administrative Court, and of 31 May 2017, No. 4 Afs 14/2017 – 36, and stated: “It follows from the above case law that the purpose of a local inquiry is to obtain preliminary or background information (“mapping of the terrain”), not to establish, verify or determine the tax liability. The latter is the purpose of the tax audit. A tax inspection is used to establish or verify the tax base or other circumstances decisive for correct determination of the tax. The scope of the rights of the tax subject corresponds to this. Finally, it follows from the aforementioned case law that the tax administrator must respect the meaning and purpose of these concepts and must not interchange them. Otherwise, it may be considered a deviation from the limits of the search activity or unlawful interference. The cited case-law cannot be interpreted as meaning that a conclusion on deviation from the limits of the legal regulation of local inquiry could be made only in those situations, where the tax administrator requires submission of complete accounting records (and possibly also records for the purposes of value added tax) and then examines them in relation to the overall tax liability of the tax subject. On the contrary, even in the case of requesting a smaller amount of documents (than the entire accounting records) and checking a smaller range of circumstances (than just all aspects of the tax liability), under the conditions emphasized in the judgment in Case No. 4 Afs 14/2017 (and indirectly in the judgment in Case No. 1 Afs 70/2004), the limits of the search activity and local inquiry may be exceeded. This will be the case in situations, where the tax administrator, instead of merely ascertaining background information and “mapping the terrain”, is in fact already ascertaining and verifying the correctness of the determination of the tax liability (see also the judgments of the Czech Court of Justice in Case No. 5 Afs 301/2019 and Case No. 7 Afs 390/2019).”

On the basis of the above, the Supreme Administrative Court evaluated the procedure of the tax administrator in the given case as a tax inspection and not as a local inquiry, as the tax administrator referred to it. The circumstances of the case were as follows. Prior to the local inquiry, the tax administrator had already asked the tax subject to submit all documents concerning the eligibility of the research and development deduction for the tax years 2010, 2012 and 2014 during the local investigation (by e-mail correspondence dated 15 December 2015). The local inquiry itself, held on 12 January 2016, the subject matter of which was defined as “obtaining information and providing supporting documents in order to verify the eligibility of the deduction for research and development on line 242 of the corporate income tax return for the tax years 2010, 2012, 2013 and 2014”, took place over a period of several hours and in addition to the tax administrator’s officials, the managing director of the tax entity, its chief accountant and an authorised representative attended it. The record of the local inquiry showed that a considerable amount of documents relating to the research and development deduction were submitted to the officials of the tax authorities and explanations were provided. The Supreme Administrative Court also emphasized that the tax administrator did not limit its actions only to the given local inquiry. First, during the local inquiry, the officials did not only study the documents on the spot, but took copies of some of the documents and took these away from the local inquiry; second, on 14 March 2016 (i.e. more than two months after the local inquiry), the tax subject provided the tax administrator with a CD containing another 40 documents relating to research and development projects for the years 2012 to 2014. The tax administrator evaluated the documents obtained. The Supreme Administrative Court stated that the described sequence of steps cannot be evaluated as a mere gathering of background information and “mapping of the terrain” (which can be carried out in the context of a local inquiry), as the above-mentioned case-law suggests. On the contrary, it is essentially a matter of ascertaining and verifying the correctness of the determination of tax liability (which is to be performed in the context of a tax audit).

Based on the above, the Supreme Administrative Court concluded in the given case that the corporate income tax audit for the tax years 2013 and 2014 in the scope of verifying the eligibility of the deduction for research and development on line 242 of the return initiated by the tax administrator on 24 May 2017 was a repeated tax audit, since in view of the time gap between the tax audit initiated in this way and the last act in the previous audit procedure (“local inquiry”), it may legitimately be assumed that the first audit procedure in the series had already been completed. Since the fulfilment of the conditions for the admissibility of a repeated audit was neither asserted by the tax administrator nor emerged from the case file, the Supreme Administrative Court held that the tax audit initiated on 24 May 2017 was initiated in violation of the law. 

In its judgment of 15 March 2022, No. 7 Afs 39/2020 – 29 , the Supreme Administrative Court dealt with the issue of the alleged limitation of the right to determine the tax, since the actual moment of commencement of the tax audit was disputed between the parties – if it was the drawing up of the protocol on the commencement of the tax audit on 2 April 2015, or the procedure of the tax administrator preceding the commencement of the tax audit, which the tax administrator described as a search activity. As part of this procedure, in order to verify the individual facts arising from the corporate income tax return for 2013, or to investigate the accuracy of the data provided in this return, the tax administrator continuously requested explanations, documents and accounting records from the tax entity in the form of e-mail and telephone communication and during a local inquiry carried out on three days at the registered office of the tax entity. The Supreme Administrative Court stated that the tax administrator required the tax subject to provide such a range of information and in such a manner that corresponds to a standard random tax inspection. According to the Supreme Administrative Court, it is clear that the tax administrator did not merely collect the documents obtained, but took a detailed look at them and evaluated, if they proved the claims of the tax subject. According to the opinion of the Supreme Administrative Court, it was essentially a classic determination and verification of the correctness of the determination of the tax liability, which should be performed within the framework of a tax audit. 

The procedure of the tax administrator following the drawing up of the protocol on the commencement of the tax inspection on 2 April 2015 did not differ from this “pre-audit” stage. The tax administrator continued uninterruptedly to communicate its requests via e-mail communications continuously, reflecting and building on its findings from the “pre-audit” stage. The Supreme Administrative Court assessed that by drawing up the protocol on 2 April 2015, the tax administrator essentially merely “processed” the actual ongoing tax inspection, thereby simultaneously mending the previous formal shortcomings of its procedure. However, the drawing up of the protocol on 2 April 2015 does not change the fact that the tax administrator had in fact and materially initiated the tax audit several months earlier and that it went on uninterruptedly until the discussion of the tax audit report. According to the Supreme Administrative Court, therefore, the date, from which the three-year period for the determination of the tax started running again, was not 2 April 2015, but 5 November 2014 already, when the tax administrator commenced the inspection activity, following the definition of its subject and scope (on 3 November 2014). In the given case, this conclusion had the effect that the tax was assessed after the expiry of the limitation period for the assessment of the tax. 

The Supreme Administrative Court also emphasized the difference from the case dealt with in the judgment of 1 March 2022, No. 7 Afs 231/2021 – 31, where the drawing up of the protocol on the commencement of the tax audit on 24 May 2017 was assessed as a repeated tax audit, as opposed to the case at hand, where the Supreme Administrative Court concluded that the tax audit, which had already been factually and materially commenced (on 5 November 2014), continued without interruption until the discussion of the tax audit report. The Supreme Administrative Court stated to this: “The fact that according to the content of the file material the tax administrator was performing inspection of the complainant uninterruptedly throughout the entire period from 5 November 2014, without any significant time intervals between the individual acts, or without any prolonged interruption of the inspection activities, makes the case under consideration different from the one dealt with by the Supreme Administrative Court in its judgment of 1 March 2022, no. 7 Afs 231/2021 – 31”. 

Consequences of exceeding the scope of search activities carried out prior to the commencement of a tax audit

(a) the illegality of that tax audit for failure to meet the conditions for its repetition, i.e. an illegal repeat tax audit, or

(b) mending procedural shortcomings of the previous procedure of the tax administrator, which was in fact a tax inspection and not a search activity. In such a case, the act affecting the time limit for tax assessment is the actual commencement of the search activity, not the formal commencement of the tax audit. 

It further follows from the aforementioned case law of the Supreme Administrative Court that the difference between these two consequences lies in the time lag between the last act of the search activity and the commencement of the tax audit. However, the question remains unresolved, as to where the time limit lies, where it is still an uninterrupted continuation of the previous tax audit actually carried out and where it is already a repeated tax audit. However, the Supreme Administrative Court did not specifically comment on this issue. In its judgment of 1 March 2022, no. 7 Afs 231/2021 – 31, the Supreme Administrative Court considered as a repeated tax audit an audit initiated more than 1 year after the last act of the search activity. The Supreme Administrative Court came to the conclusion on uninterrupted continuation of a tax audit that had already been effectively initiated in its judgment of 15 March 2022, No. 7 Afs 39/2020 – 29 in the case of a time gap of several days between the last act of the tax administrator’s search activity and the initiation of the tax audit. 

We are currently dealing with a situation of a client before the Supreme Administrative Court, where the time interval between the last act of the tax administrator and the commencement of the audit was approximately 3.5 months, which the Regional Court assessed as an insufficient time interval to constitute unlawful repeated tax audit. We will keep you informed of the outcome of the review of the matter.

If you are interested in this topic or you are currently dealing with a similar problem, please, do not hesitate to contact us, we will be happy to help you.

Author: Jaroslava Půtová, Petra Janďourková