Tax inspection: what are the rules of play?
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Sooner or later all entrepreneurs are confronted with an inspection by the Tax Authority. This inspection may not only focus on the entrepreneur’s liability to pay tax, but also that of a third party (e.g. his customer or supplier). The Tax Authority has several possibilities for inspecting an entrepreneur. For example, the inspector may conduct an audit, visit the company or carry out an on-site observation. Experience shows that the Tax Authority is currently inspecting entrepreneurs’ balance sheet item, turnover tax. The strategy applied by the Tax Authority indicates that this inspection primarily focuses on investigating an entrepreneur’s culpability. That should set off the entrepreneur’s alarm bells immediately. What are our rights and obligations during a Tax inspection? Is the entrepreneur obliged to cooperate in establishing his/her culpability? I deal with these topics in this blog.
Various inspection possibilities
The tax inspector has several possibilities for conducting an inspection on an entrepreneur. Firstly, the inspector may conduct an audit. The purpose of an audit is usually to inspect the entrepreneur’s tax returns and administration. The inspector may opt to audit a specific period or specific components of the tax returns and/or administration. The inspector usually spends (part of) a day at the entrepreneurs place of business to conduct the inspection. The inspector may also ask the entrepreneur questions during the inspection. The inspector also uses this inspection, for example, for the (latest) examination of an entrepreneur’s balance sheet item, turnover tax.
Another possibility is that the inspector wants to gain insight into the entrepreneur’s company and business procedures. In most cases, the inspector will visit the entrepreneur’s business premises.
The inspector may also carry out an on-site observation. The inspector does this to establish with his/her own eyes what actually takes place within the company on a day-to-day basis. The inspector does not give advance notice of this visit and it can therefore be labelled a ‘surprise visit.’ This strategy is frequently applied in hotel and catering establishments.
Finally, the inspector may conduct a so-called third-party investigation. This third-party investigation may focus on the taxation of the entrepreneur him/herself or that of a third party (e.g. one of the entrepreneur’s suppliers or customers). In the latter case, the entrepreneur will be confronted with a third-party inspection. In the first case, a third party, one of the entrepreneur’s customers or suppliers, will be confronted with an inspection by the inspector.
An entrepreneur has rights and obligations with respect to all of these inspections conducted by the Tax Authority. It is important to bear that in mind, so that no information can be provided involuntarily that the inspector may use against the entrepreneur later on.
The point of departure for an entrepreneur’s obligations is the obligation to file a tax return in Articles 6 to 10 inclusive of the General Tax Act (hereafter referred to as: AWR). These are also called the primary obligations. In the majority of cases the primary obligations will not be addressed during a tax inspection, but rather the additional obligations of Articles 47-56 of the AWR. The most familiar additional obligations are: the obligation to provide information (AWR, Article 47) and the obligation to keep records and the obligation to retain (AWR, Articles 52 and 53).
Obligation to provide information (AWR, Article 47)
The obligation to provide information means that the entrepreneur is obliged to answer the inspector’s questions that are relevant for the imposition of taxes. This seems straightforward enough, however, in practice, it is not quite as straightforward as it seems. The inspector may, for example, only inquire about the facts and not the entrepreneur’s opinion. The inspector is not allowed to ask the question ‘Was trade in clothes the source of income?’ Instead, the inspector asks the entrepreneur to qualify certain facts (source of income). The inspector is allowed to ask ‘Have you purchased or sold clothes?’ This could be followed with: If yes, ‘for how much did you purchase or sell the clothes?’ etc., etc.
Another obstacle that may arise is the question how should the entrepreneur respond if the question is relevant for imposing taxes as well as for imposing a punitive fine. Any entrepreneur would, of course, be quick to say that they are not obliged to cooperate in their own conviction. But can he or is he entitled to do so? Unfortunately not. The entrepreneur is obliged to answer the so-called ‘mixed’ question. The only restriction is that the inspector is not allowed to use the answer to substantiate the fine. The entrepreneur is only entitled to invoke his/her right to remain silent on questions that are directly related to the imposition of a fine.
Under Article 47 of the AWR, the entrepreneur is also obliged to allow the inspector to examine the accounts, documents and other data carriers at its request. This obligation does not, however, entitle the inspector to an unlimited right to inspect. I discuss this in more detail under the entrepreneurs ‘rights.
Obligation to keep records and obligation to retain (AWR, Articles 52 and 53)
The entrepreneur’s obligations to keep and retain records are laid down in Article 52 of the AWR. Article 53 of the AWR subsequently stipulates that the entrepreneur is obliged to allow the inspector to examine his/her administration for the purpose of his/her own taxation and/or that of a third party.
The obligation to keep records enables the inspector to easily check that the entrepreneur complies with his/her rights and obligations for the tax levy. How the administration has to be set up and what it should include is not provided for in the legislation. What exactly should be included in the entrepreneur’s administration depends on the nature and size of the business. The administration may include:
- cash transactions and receipts;
- financial statements, like purchase and sales ledger;
- incoming invoices and copies of outgoing invoices;
- bank statements;
- contracts, agreements and other arrangements;
- agendas and appointment books;
The obligation to retain – in short – means that the entrepreneur is obliged to retain the administration for 7 years. Data on immovable property (deed of sale and civil-law notary invoice) are even subject to a retention period of 9 years.
In addition to the abovementioned obligations, the entrepreneur also has a number of rights. While the obligations are clearly set out in Articles 47-56 of the AWR, the entrepreneur’s rights are mainly to be found in the case law and the general principles of sound administration.
The most significant right that will spring to everyone’s mind is the right to remain silent. In tax audits, an entrepreneur can avail of this right sporadically. As already explained, an entrepreneur is obliged to answer the inspector’s questions. The entrepreneur is only entitled to invoke his/her right to remain silent on questions that are directly related to the imposition of a fine. The inspector shall caution the entrepreneur before asking a question that is directly related to a fine, so that the entrepreneur knows that he/she is not obliged to answer.
As already mentioned, the inspector assesses entrepreneurs’ balance sheet item for turnover tax. The inspector has drawn up a contingency plan for this inspection. According to this contingency plan the inspection of the balance sheet item, turnover tax, that is conducted at the entrepreneurs place of business is really only to establish the entrepreneur’s culpability (the liability). It is also noted in the contingency plan that, depending on the outcome of the inspection, a fine will be imposed on the entrepreneur. It can be deduced from this that if the inspector asks the entrepreneur any questions during the examination of the balance sheet time, turnover tax, these questions will only be pertinent the (possible) imposition of a fine. Consequently the entrepreneur is entitled to invoke his right to remain silent during this inspection.
Another right that the entrepreneur has is in fact a ban that the inspection has, namely the ban on browsing and/or the ban on fishing expeditions. The inspector may not, for instance, take it on himself to open or enter filing rooms looking for documents that may be interesting for tax purposes. The inspector will have to ask the entrepreneur have a specific document. Nor may the inspector sit behind the entrepreneur’s computer to look for documents that may be interesting for tax purposes. On the contrary, the inspector may ask to link his computer to the entrepreneur’s computer to facilitate the transfer of data.
In most cases, the entrepreneur will avail of the services of an accountant, tax consultant, civil-law notary and/or lawyer. Lawyers and civil-law notaries have a legally arranged right to non-disclosure (AWR, Article 53a). If the entrepreneur has received any correspondence and/or advice from a lawyer and/or civil-law notary (the latter is subject to some restrictions), the inspector is not at liberty to ask for these to be made available for inspection. Not even if the entrepreneur has included this correspondence and/or advice in his administration. This does not apply in the case of accountants and tax consultants. The do not have a legally arranged right to non-disclosure. Nonetheless, the inspector may not request that correspondence and/or advice from the accountant or tax consultant is made available to him for inspection if the object of that request is to advise the entrepreneur about his tax position. The fair play principle precludes the inspector from requesting to inspect.
It is important for an entrepreneur to take stock of these rights. During an inspection, the inspector is usually extremely eager to obtain as much information as possible. The accusation that the inspector is quick to make is that entrepreneurs look for loopholes in the law. The inspector understands what it is to be human. The inspector often treads the borderline between what may and may not be asked into order to obtain as much information as possible. So, be on your guard!
The abovementioned is a brief outline of the various types of inspections that may be conducted by the Tax Authority. I also briefly discussed the obligations and rights that an entrepreneur has during such an inspection. It is important that an entrepreneur is aware of these, so that he does not involuntarily provide information to the inspector that can be used against him later. This situation may arise when the inspector is examining the entrepreneur’s turnover tax balance sheet item. The contingency plan drawn up for such inspections shows that the only reason for conducting the inspection is to determine the culpability of the entrepreneur. This means that the entrepreneur is entitled to invoke his right to remain silent. If he does not do this and voluntarily provides information to the inspection, the inspector may use that information against him to substantiate the fine. For more information on this subject, please refer to the Tax Inspection guide, which you will find here.