In early October, the Finance Court of Cologne published its decision of 7 July 2009 regarding the lawfulness of short-term tax audits.
In the case under consideration, the taxpayer was classified as a “large” firm based on its profit and turnover. The local tax authority chose the plaintiff for a tax audit that would cover only the year 2007. The plaintiff appealed against the order asking for a preliminary injunction (vorläufiger Rechtsschutz) against the conduct of the tax audit.

The court granted the injunction due to serious doubts as to whether the audit’s time limitation, based on company size alone, was lawful.
Under German tax law, audits are allowed in regard to taxpayers who conduct commercial or freelance work or other taxpayers whose annual income exceeds EUR 500,000.
In general, the local tax authorities are competent in regard to tax audits and are given discretion as to the taxpayers, the type of tax, the circumstances and the time frames to be audited. However, the Ministry of Finance, in the Tax Audit Regulations (Betriebsprüfungsordnung or BpO) has issued administrative regulations as to how such discretion must be exercised.

Sec. 4 II of the Tax Audit Regulations defines that large firms are to be audited regularly without disregarding any fiscal years. The practice in this regard over the last few decades has been to audit large firms over a three-year term.

In June 2008, the Ministry of Finance of the German federal state of Northrine-Westfalia issued a decree that allowed the conduct of single-year audits – so-called “prompt tax audits” (zeitnahe Betriebsprüfung) in order to generate additional taxes as well as to create legal certainty for taxpayers.

In the case under review, the Finance Court of Cologne held that the discretion of the tax authorities regarding the term to be audited can be exercised only to the extent to which it does not infringe the principle that the administration is bound by its own practices with the result that if a tax authority generally audits over a three-year period, it cannot generally conduct shorter-term audits. The Court further noted that since tax audits are a limitation of taxpayers’ rights – particularly for large firms for which tax audits are costly and time-consuming – a reduction of the audit term, with the corresponding increase in effort and expense for the taxpayer, must be supported by valid reasons. The Finance Court of Cologne further held that the categorization of a company as a “large firm” is not, in itself, sufficient to justify a one-year audit term.
Since the case under consideration only involved the granting of a preliminary injunction for the conduct of the audit, the tax authority must still decide whether to allow the appeal and thereby accepting the decision or to provide further justification for the shortened term.

Furthermore, since the rule of precedence is not a part of the German justice system, other courts and tax authorities are not bound by the decision of the Finance Court of Cologne. However, this decision could be cited in other cases as argumentation against a shortened audit term.