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 breach found, the tax authorities may apply interest, surcharges or fines, and certain situations may also lead to criminal prosecution.

Not all irregularities, however, are equally serious.

A late return, a good-faith error, a deliberate omission, conduct designed to conceal a transaction or obstruction of an audit fall under different regimes and may lead to very different consequences.

One of the key issues in a tax audit is therefore to examine not only the additional tax claimed, but also the characterisation of the taxpayer’s conduct adopted 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 statutory time limits, Article 1727 of the French General Tax Code (Code général des impôts, CGI) provides for late-payment interest.

This must be distinguished from tax surcharges and fines. It does not, in itself, penalise wrongful conduct: it applies irrespective of the taxpayer’s intent 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, i.e. 2.40% a year.

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

Late-payment interest may thus accompany a reassessment without the tax authorities necessarily accusing the taxpayer of seeking to evade tax.

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

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 return filed late may in particular give rise to a 10% surcharge. This may rise to 40% where the taxpayer does not regularise their situation within thirty days of a formal notice.

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

Special 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 breach and fraudulent conduct: the taxpayer’s intent becomes decisive

The 40% surcharge cannot be based on a mere error

Where the tax authorities consider that an understatement or omission was deliberate, they may apply the 40% surcharge for deliberate breach (manquement délibéré) provided for in Article 1729 of the CGI.

This characterisation requires more than a finding that an error was made.

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

To establish this intent, the tax authorities may rely on various indications: the size or repetition of the omissions, the nature of the transactions concerned, the fact that the taxpayer must have known that the transactions were taxable or certain accounting practices found during the audit.

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

A reassessment may be disputed in principle or in amount, while the penalty may at the same time be challenged on the ground that the tax authorities have not sufficiently demonstrated that the breach was deliberate.

The surcharge may reach 80% where concealment is found

A finding of fraudulent conduct (manœuvres frauduleuses) leads to an 80% surcharge.

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

It is no longer merely a deliberate omission: the tax authorities must identify devices intended to conceal the irregularity, to give it an appearance of regularity or to complicate the audit and verification operations.

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

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

Other conduct may lead to yet different penalties. Obstruction of a tax audit may in particular lead to an ex officio assessment and a 100% surcharge on the additional tax.

At this stage, analysing the characterisation adopted by the tax authorities becomes essential: the choice between error, deliberate breach, fraudulent conduct or obstruction of an audit can considerably change the final cost of the reassessment.

3. Tax fraud: in what cases can an audit have criminal consequences?

Certain situations may lead to prosecution in addition to tax penalties

Tax law does not provide only for administrative penalties.

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

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

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

Such a combination 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 the seriousness of the fraud in the specific circumstances of the case 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 that have given rise to surcharges of 100%, 80% or, in specific circumstances, 40%, where the additional tax exceeds 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.

The criminal risk must therefore be identified early enough where the nature of the facts or the penalties envisaged may take the case beyond the scope 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, to check whether the conditions for applying the surcharges are met and to challenge findings of deliberate breach, fraudulent conduct or abuse of law where they are not sufficiently established.

Based in Nice, the Valenor firm assists taxpayers throughout the tax audit in order to anticipate the financial consequences and, where it exists, the criminal risk attached to the proposed adjustments.

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 be specifically analysed.

Bruno Gherardi
Tax lawyer in Nice - Cabinet Valenor