Tax audits: how far can the penalties go?

A tax audit may lead to far more than a simple demand for back tax. Depending on the nature of the failure identified, the tax authorities may apply interest, surcharges or fines, and certain situations may also result in criminal prosecution.

Not all irregularities are equally serious, however.

A late return, a good-faith error, a deliberate omission, schemes designed to conceal a transaction or obstruction of an audit are each governed by different regimes and may lead to very different consequences.

One of the key issues in any tax audit is therefore to examine not only the additional duties claimed, but also the characterisation of the taxpayer's conduct relied on by the tax authorities to justify the penalties applied.

1. Tax penalties: not all irregularities are penalised in the same way

Late-payment interest: a financial consequence distinct from a penalty

Where tax has not been paid within the time limits laid down by law, Article 1727 of the French General Tax Code (CGI) provides for late-payment interest to be applied.

This must be distinguished from tax surcharges and fines. It does not, in itself, penalise wrongful conduct: it applies regardless of the taxpayer's intention and is intended to compensate for the delay with which the State received the sums owed to it.

Its rate is set at 0.20% per month, or 2.40% per annum.

Its application is nevertheless subject to several exceptions and adjustments. Regularisation during an audit under the conditions laid down in Article L. 62 of the French Tax Procedures Code (LPF) makes it possible, in particular, to benefit from a 30% reduction in late-payment interest.

Late-payment interest may therefore accompany a reassessment without the tax authorities necessarily accusing the taxpayer of any intention to evade tax.

Late or missing returns: surcharges that increase with the seriousness of the failure

Failure to file, or late filing of, a return may also lead to the surcharges provided for in Article 1728 of the CGI.

Their level varies according to the situation.

A late return may in particular give rise to a 10% surcharge. This may be increased to 40% where the taxpayer fails to regularise their position within thirty days of a formal notice.

Where there is an undisclosed activity, the surcharge may reach 80%.

Specific provisions apply to income tax. Depending on the circumstances of the late filing, the applicable surcharge may in particular be 10% or 20%.

The date on which the return was filed, whether a formal notice was issued and how quickly the situation was regularised may therefore have a direct bearing on the amount of the penalties.

2. Deliberate failure and fraudulent schemes: the taxpayer's intention becomes decisive

The 40% surcharge cannot be based on a mere error

Where the tax authorities consider that an understatement or omission in a return was made deliberately, they may apply the 40% surcharge provided for in Article 1729 of the CGI for deliberate failure.

This characterisation requires more than the mere finding of an error.

The tax authorities must establish that the taxpayer was aware of the elements that led to the reassessment and nevertheless deliberately omitted or understated the sums that should have been declared. The burden of proving that the failure was intentional lies with the tax authorities.

To establish such intent, the tax authorities may rely on various indicators: the size or repetition of the omissions, the nature of the transactions concerned, knowledge that they were necessarily taxable, or certain accounting practices observed during the audit.

Challenging a 40% surcharge therefore requires an analysis separate from that concerning the merits of the reassessment itself.

An adjustment may be disputed as to its principle or its amount, while the penalty may at the same time be challenged on the ground that the tax authorities have not sufficiently demonstrated the deliberate nature of the failure.

The surcharge may reach 80% where concealment is found

A finding of fraudulent schemes (manœuvres frauduleuses) results in an 80% surcharge.

It presupposes a further degree of seriousness in the conduct alleged against the taxpayer.

It is no longer merely a matter of a deliberate omission: the tax authorities must identify arrangements designed to conceal the irregularity, to give it an appearance of regularity or to hinder the audit and verification process.

The 80% rate may also be applied in cases of abuse of law under Article L. 64 of the LPF.

This surcharge is, however, reduced to 40% where it has not been established that the taxpayer was the principal instigator of the acts constituting the abuse of law or its principal beneficiary.

Other conduct may lead to different penalties again. Obstruction of a tax audit may in particular result in an ex officio assessment and the application of a 100% surcharge on the duties reassessed.

At this stage, analysing the characterisation adopted by the tax authorities becomes essential: the choice between error, deliberate failure, fraudulent schemes or obstruction of an audit may considerably alter the final cost of the reassessment.

3. Tax fraud: when can an audit have criminal consequences?

Certain situations may give rise to prosecution in addition to tax penalties

Tax law does not provide solely for administrative penalties.

Article 1741 of the CGI also makes tax fraud a criminal offence where the taxpayer has sought fraudulently to evade, in whole or in part, the assessment or payment of tax.

The offence requires two elements: acts or conduct enabling tax to be evaded, and fraudulent intent.

In certain cases, tax penalties and criminal penalties may be cumulative.

Such cumulation is not, however, automatic. It is subject to several limits, relating in particular to the seriousness of the facts and the proportionality of the penalties.

Before imposing a criminal sentence in addition to the tax penalties, the court must in particular assess in concrete terms the seriousness of the fraud in the light of the amounts at stake, the nature of the methods used and the circumstances in which the acts were committed.

Certain cases are automatically referred to the public prosecutor

Since the Law of 23 October 2018 on combating fraud, the tax authorities have been required, in certain situations, to refer the facts to the public prosecutor.

This obligation concerns in particular certain cases in which surcharges of 100%, 80% or, in specific circumstances, 40% have been applied, where the duties reassessed exceed 100,000 euros.

Outside these cases of mandatory referral, the tax authorities also retain the option of filing a complaint under the conditions laid down in Article L. 228 of the LPF.

Criminal exposure must therefore be identified at a sufficiently early stage where the nature of the facts or the penalties envisaged are likely to take the case beyond the confines of tax litigation alone.

The involvement of a tax lawyer makes it possible to examine separately the merits of the adjustments, the penalties applied and the evidence used by the tax authorities to characterise the taxpayer's conduct.

It also makes it possible to identify the options for regularisation, verify whether the conditions for applying the surcharges are met and challenge findings of deliberate failure, fraudulent schemes or abuse of law where they are not sufficiently established.

The firm supports taxpayers throughout the tax audit in order to anticipate the financial consequences and, where it exists, the criminal exposure attached to the adjustments envisaged.

The aim is never to treat penalties as an automatic consequence of the reassessment: their basis, their rate and the characterisation of the taxpayer's conduct must each be the subject of a specific analysis.