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Tax audit: initiation, process, statute of limitations

Thanks to their digital tools, French tax services are conducting an increasing number of checks. Here is what taxpayers need to know.

Reading Time : 6 minut(s) - | Updated on 25-03-2024 09:02 | Published on 07-04-2023 10:52 

The number of tax audits is on the rise

The number of checks carried out by the Directorate General of Public Finance (DGFiP) has been steadily increasing for several years. In 2022, following tax audits, the State recovered 14.6 billion euros (approximately 16.5 billion dollars). It thus recouped over 10 billion dollars from individuals and companies.

According to its activity report, the administration carried out over 1.1 million checks last year, a third of which were on companies. Most of these procedures are carried out without the taxpayer being informed. However, when a situation appears unclear, a thorough check may follow. Sometimes, it leads to a procedure called contradictory examination of personal tax situation (ESFP).

Taxpayers declaring the highest incomes and assets are more often audited. According to the DGFiP, "high stakes" files undergo a paper-based compliance check every 3 years. The "most significant" 4000 files are monitored by the National Directorate for the Verification of Tax Situations (DNVSF).

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The tax authorities have increasingly sophisticated tools

In order to better assess the risks of tax fraud, the tax services have equipped themselves with efficient digital tools. These allow for the cross-checking of dozens of taxpayer information.

Programming services create algorithms using datamining and artificial intelligence processes, which bring to light files containing inconsistencies. This is increasingly the case for property tax, for example, to detect unreported pools and verandas.

Agents then check the files that have come up. According to the 2022 Public Finance report, 52% of the total tax audit programming is now performed on this basis. The software in particular has allowed 3,000 letters to be automatically sent to taxpayers who have omitted certain revenues in their 2020 declaration.

What can trigger a tax audit

Technology allows for increasingly refined data and complex situation analysis. However, some signals are likely to draw special attention from the tax authorities. They include, among others: - Incongruent information among the various state services such as CAF, URSSAF, taxes; - A significant variation of income from one year to another, especially when it’s unexplained. For example, it might be a drop in rental income while the property assets remain unchanged; - The presence of a substantial real estate deficit. For rental properties taxed under the real regime, taxpayers can deduct certain charges (management fees, works, insurances...). When these charges surpass the rental income, a real estate deficit is created with the effect of reducing the income tax base. The administration can check the reality and eligibility of the deducted charges; - Transfer of property, particularly during gifts and succession. Bare ownership gifts are targeted for instance, as tax authorities often view them as solely tax-motivated. This falls under the definition of an abuse of rights (see our info box); - Errors or delays in declarations; - Owning an undeclared foreign bank account. Accounts opened on cryptocurrency platforms and foreign banks (Revolut, N26...) ought to be declared during the annual income declaration. Yet, some taxpayers are unaware of this; - A property that seems undervalued. This can occur during a declaration, sale, gift or inheritance, which can lessen the taxable base of taxes and duties. This is especially the case during wealth tax on real estate (IFI) declarations; - A series of tax reduction operations. In the eyes of the tax authorities, the primary motivation of an investment or a scheme should not be to downplay or avoid tax; - Complex setups, which may hide the creation of an abusive system that is solely tax-oriented; - A lifestyle that seems inconsistent with the declared income. The administration can consult posts published on social media and trigger an audit in case of a manifest discrepancy; - Family loans, as these can be viewed as disguised gifts. These loans have to be declared when they exceed 5000 euros. Plus, it’s better to establish a debt acknowledgment; - Furnished rentals, specifically when it allows the benefit of amortizing the property purchase price; - Placing your own company’s shares in a PEA. According to the tax administration, it is prohibited to place in a PEA shares that are already owned. For example, when creating a holding company and reselling the shares in two stages to the taxpayer within his PEA. These structures may be subject to reassessment; - A report or suspicion following a third-party tax audit; Of course, this list is not exhaustive. Conversely, each of these events does not necessarily result in systematic checking. Abuse of rights: definition Abuse of rights involve carrying out a fictitious act or a structure aiming to avoid a tax or to lessen it. This notion of rights is derived from article L64 of the Book of Tax Procedures (LPF).

How does a tax audit proceed

When an event brings a case to light, tax service agents can carry out manual checks. They initiate a tax control procedure here, the first level of which is control over documents.

The administration will first verify alone, based on the information contained in the taxpayer's tax file, that the declarations are not erroneous. In this context, it can ask the individual concerned to provide additional documents, for example to justify the benefit of a tax reduction.

The controller then sends a request for clarification by regular mail. In case of deeper doubt, the administration may require a response within 60 days. Businesses are then likely to be sent a notice of accounting verification.

It is better to open dialogue with the tax services. Most situations are resolved quickly as long as the taxpayer acts in good faith. Once the response is sent, the file is closed if the tax authorities do not respond within the deadline indicated when requesting.

Conversely, in case of persistent doubt, tax services can initiate a procedure for contradictory examination of personal tax situation (ESFP). The controller will check the consistency between the declarations and the movements on bank accounts. The taxpayer can here turn to a tax lawyer to defend his rights.

These two procedures can result in a tax adjustment. The tax services then send a substantiated rectification proposal. This may include the collection of late tax, but also penalties or interest, an increase or a fine.

If the taxpayer is in good faith, he can be fined with a 10% increase for late payment. If he is considered in bad faith, he can suffer a 40% increase for deliberate failure. Finally, in case of fraudulent maneuver, illegal activity or abuse of rights, the increase can reach 80%.

Fraud is also punishable by criminal fines, or even imprisonment.

Audit, penalties, tax adjustment: what recourse

If the authorities have ruled against them, taxpayers have the right to defend themselves in several ways.

They have the right to submit a gracious appeal to the tax services. The objective is to request the cancellation or reduction of a surcharge or penalties.

If the dispute involves payment deadlines or a penalty waiver, the tax conciliator of the department can be seized. His task is to find an amicable solution. In case of failure, taxpayers have the option of turning to the ombudsman for economic and financial ministries.

Taxpayers also have the option of filing a hierarchical appeal with the auditor's supervisor, during or following the audit. However, such action does not suspend ongoing operations. If the problem persists, they can bring their appeal to the departmental manager.

The taxpayer also has the right to dispute a tax adjustment. If the quantities are not daunting, he can do it on his own. A tax lawyer, however, can be of great help as soon as the financial stake becomes significant.

Finally, the taxpayer can appeal to the court. Depending on the type of tax, it will be the administrative court or the high court that will be competent. The judge will then make the final decision on the dispute. The judgment may be appealed to the Court of Appeals and in Cassation, or even to the Council of State.

Tax audit: what is the statute of limitations

Tax audits can span over the last 3 years in addition to the current year. If you're audited in 2023, the administration is capable of verifying declarations from 2022, 2021, and 2020. However, they can request supporting documents older than these periods.

But there are exceptions: this period can be longer. For the Real Estate Wealth Tax (IFI), the period is extended to 6 years in case of non-filing or omission.

For bank accounts held abroad that are not reported to the administration, the expiration period extends to 10 years.