Behind the Scenes: How Covert Tax Audits Start and What to Expect

Tax authorities have learned to be cautious about covert tax audits. There’s a distinction between what the tax office might ask for “just like that” and what constitutes a full audit, as explained by Václav Čepelák, a tax dispute expert at BDO.

Understanding Covert Tax Audits

While there ideally shouldn’t be covert tax audits, they can occur in practice. You might notice this happening when the tax administrator requests a large number of documents without formally initiating an audit or at least addressing any doubts regarding your submitted tax return.

Although the tax office can check taxable entities and evidence through less formal procedures, it shouldn’t scrutinize the tax base itself or conduct more extensive investigations without proper protocol. This issue gained attention in the professional community after the Czech Ministry of Finance proposed changes to the Tax Code in May to clarify the powers of tax administrators, although those changes ultimately did not pass.

Procedures for Tax Reviews

Typically, the Financial Administration, acting as the tax administrator, reviews the tax obligations of businesses when violations are suspected. Minor inquiries may arise during standard control activities. However, if the tax administrator has clear suspicions that you haven’t fully declared your income on your tax return, they should initiate a formal procedure to eliminate doubts or conduct a tax audit, both of which have established rules. Unfortunately, the law does not clearly define the line between what constitutes clarification and information gathering versus what qualifies as a full tax audit.

This is why, in certain cases, the tax administrator may engage in actions known as “hidden tax control,” a term that has emerged in the case law of administrative courts regarding the procedures of tax administrators. This doesn’t necessarily indicate bad intent on the part of the tax administrator; it may simply reflect a misjudgment of the procedural situation or an attempt to streamline their activities. However, if the tax administrator bypasses the formal requirements for conducting a tax audit, it could backfire if the client actively defends their rights. As with many other situations, it’s best to address this issue as early as possible, ideally at the first request from the tax administrator.

Hidden tax control is difficult to prove, and there is no official definition for it. If there is a dispute between you and the tax administrator over whether it constitutes a hidden tax audit, only an administrative court can effectively resolve the matter. In specific cases, the factual circumstances play a crucial role in the court’s decision, and the “history” of the case is significant. Therefore, even if courts define what prompted a tax administrator to conduct a covert audit in a particular instance, these rules cannot always be generalized.

Case Study: Signs of Covert Tax Audits

The Supreme Administrative Court has emphasized multiple times, in various contexts, the need to “comprehensively understand the situation from the perspective of legislation and related judicial practice” and to “assess the factual circumstances in detail.”

For example, in one case resolved by the court, the company carefully documented and presented all the signs of a covert tax audit conducted by the tax administrator, as indicated in previous case law. This meant that the tax administrator:

• Requested very specific documents from the client as part of their investigative activities, including evidence of particular transactions.
• Repeatedly asked the client for additional evidence and information regarding these transactions.
• Sought further documents and evidence from third parties.
• Examined the client’s tax base.
• Evaluated the evidence received.

All of these actions are clear indicators of covert tax control, as determined by earlier decisions from administrative courts. However, both the regional court and the Supreme Administrative Court concluded that this particular case did not constitute a prohibited covert tax audit because they viewed the tax administrator’s activities as not particularly intensive overall. This highlights the ambiguity surrounding the boundaries of covert tax control.

Initially, companies may find a less formal approach comfortable, but this can change over time. At first, a less formal audit might seem advantageous to taxpayers, allowing them to send data and documents via email or have a local investigation conducted by the tax administrator.

However, once the tax administrator’s activities intensified—such as multiple visits or repeated requests for documentation like invoices, contracts, delivery notes, and other evidence—the initial benefits for the taxpayer often disappeared. Taxpayers began to push back against these demands, which contributed to the evolving practice of administrative courts regarding hidden tax control.

The Comfort of Informal Audits

In the practice of administrative courts, there is a tendency toward “balancing.” Initially, there was a pushback against state power, with courts discouraging tax authorities from conducting overly broad search activities, labeling them as prohibited hidden tax audits. However, as the number of hidden tax control cases increased and less serious cases started reaching the courts, administrative courts gradually began to adjust their conclusions, clarify their positions, and even “soften” their stance toward the tax administrator.

From the perspective of companies, it’s crucial to be prepared for such situations. Don’t be intimidated by the tax administrator; if you suspect a hidden tax audit, stand your ground against the Financial Administration and assert your rights.

Contact 360WEDO for Tax Assistance

Get in touch with the tax specialists at 360WEDO. We’ll ensure all your calculations are accurate, allowing you to focus on running your business while we take care of your accounting needs. This version maintains clarity and a friendly tone while improving readability.

Source:

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