Criminal Tax Law: Tax evasion by foreign IT freelancers?

Since 2010, some tax offices and public prosecutors in Germany have been prosecuting foreign IT experts who worked as freelancers in Germany on suspicion of tax evasion.

German Version:

Steuerstrafverfahren gegen ausländische IT-Spezialisten (Teil 1)

Read more about the topic:

Criminal Proceedings for Tax Fraud against IT Specialists from Abroad

IT freelancer Tax evasion

I. Background: Foreign IT Freelancers in Germany

Concerned are highly qualified programmers or technicians who are or have been working for various companies with offices in Germany (such as Siemens, Infineon, EADS, O2 / Telefonica, Comneon, Dornier, Telekom, Philips, NXP, Sony Ericcson) in the fields of development, construction and innovation, in some cases for longer periods of time.

The consultants usually work as freelancers. They were contracted by agencies such as Abraxas, Ocean Management Ltd, SBS, Ross Management Ltd., Eurosearch. Payments were regularly made via so-called management companies, in particular:

* Project Service Beta S.A. – PSB
* Albany Technologies Ltd.
* Albany Systems Ldt.
* SMTG/Integra
* Filetravel Overseas
* Access Financial SARL
* Jadelogic Ltd.

No contracts of employment were concluded with the German contracting companies directly. The settlement of the projects was carried out within the scope of service contracts. These service contracts were usually drawn up as fixed-term “project contracts” and concluded with the respective agencies or management companies, which usually had their domicile abroad.

The German tax offices suspect the accused of systematically evading tax.
In doing so, the agencies that received the money from agencies or contracting companies are said to have split up the money. The suspicion is that only a part of the fees taken were declared to the tax authorities. A further share is said to have been placed in accounts by the agencies abroad for that purpose (offshore accounts, also called trust accounts or cash management accounts). In this context, one also speaks of a “trust model” or a “split income method”.

The tax fraud investigations presume that there were “secret” agreements between the agencies and the consultants. According to this, German tax authorities were presented with pseudo-contracts that only relate to the money that was paid out and taxed in Germany. The consultants are said to have directed bank transfers to the account abroad. It is assumed that the option also partially existed to have the full amount paid out.

The foreign accounts are said not to have been opened in the names of the respective consultants. In fact, so-called “prefix numbers” are said to have been assigned, i.e. reference numbers by means of which, the respective credit could be assigned.

Payments from the trust accounts are said to partially have been made by means of so-called “loans”. In part, the payments are said to have been transferred directly to private accounts, for example, after the consultants had completed their work in Germany.

Nationwide tax investigations are underway which are carefully examining people who fulfil the following criteria:

* Foreign consultants
* Temporary work in certain areas of the technology sector
* Settlement as self-employed person via an agency (e.g. Project Service Beta S.A. – PSB)
* Low income in comparison to others in the trade
* Declaration of non-taxable turnover according to the Turnover tax Act, as the work was for foreign contractors only
* Advice from certain tax advisors (names known)

Preliminary proceedings against some tax advisers who played an advisory role in the processes are said to have been instituted due to their assistance in evading taxes. Even some of the managers of the respective management companies are said to have already been prosecuted.

When choosing tax advisers and criminal defence lawyers who are entrusted with the problem, the accused should make sure he is dealing with people who are not pursuing their own interests or interests of management companies that are under pressure.

II. Regulatory framework

All cases that have been revealed involved the suspicion of evading income tax. In some cases, preliminary proceedings were instituted based on the suspicion of evading turnover tax.

1. Turnover tax (VAT)

1. According to German law, the obligation to pay turnover tax only exists if a service (“Leistung”) is rendered in Germany (“Inland”) by an entrepreneur (“Unternehmer”).

According to § 2 of the German Turnover tax Act, a entrepreneur (“Unternehmer”) is a person who performs business or professional work on a self-employed basis. When judging whether “self-employment” in these terms is involved, it does not depend on what the contractual arrangements are called, but on what the case actually is. Self-employment is not involved if the German company in which the work was performed gave precise instructions regarding place, time and content of the work. Criteria for this are fixed working hours and clearly defined work, always at the same place with fixed remuneration. Further evidence would be a constant co-operation with other colleagues, incorporation into the company, an understanding that the consultant has to be present for at least a certain period of time, no own entrepreneurial risk, compensation for overtime, etc. The activities of the IT consultants known in the practice are presently classified as “self-employment”, i.e. the tax office assumes that the person concerned actually is an “entrepreneur.”

Therefore the place of performance becomes essential. This is determined by § 3a of the Turnover tax Act. In the cases in practice that have already been revealed, preliminary proceedings were initially instituted because of turnover tax evasion, because there was the suspicion that the agencies were possibly only pseudo-companies, whose sole purpose was to provide a “Post box” for the purposes of handling payments. This suspicion was not confirmed.

At present, it is mainly assumed – also on the part of the tax offices – that an obligation to opt for turnover tax does not exist in Germany.

2. Income tax

In terms of income tax, according to German fiscal law, the so-called worldwide income principle (§ 1 Section 1 Clause 1 of the Income Tax Act) applies. It states that any person living or normally residing in Germany is obliged in principle to declare all money earned throughout the world to the German authorities and to pay taxes on this according to German law. Whether someone has his residence in Germany is determined according to § 8 of the Income Tax Act, i.e. it depends on the actual domicile or on whether circumstances suggest that a residence is actually being made use of.
The legal situation regarding income tax is therefore quite simple in principle: If a consultant actually receives money via so-called offshore accounts abroad, then from an objective point of view, this is tax evasion.
The result could be different if corresponding money is taxed in a country with which a double tax agreement exists. Such constellations, however, have not been known in practice.

That means that the German tax authorities can demand supplementary tax on income. If one assumes deliberate tax evasion, then the tax statements of the previous 10 years can be altered. Factually, the period is often 11 or 12 years because the 10-year period does not usually commence with the end of the year.

In the case of tax evasion, 6% tax evasion interest has to be paid in addition to the remargined taxes.

The tax authorities are currently tending towards lumping together all similar cases. This goes to such lengths that tax statements were even issued in cases where it was only determined that on the part of the contracting company, more money was paid to the agencies than the consultants received (after deducting agency and handling fees between 4% and 20%).

In the end, speculations form the basis of the work. Such tax estimations are likely to have exceeded the limitations of what is constitutionally permissible. According to the current state of knowledge, there are indications that management companies have kept money for their own purposes meaning the consultant never had access to it. In many cases, those involved did not even know that in some cases, the contracting companies paid the agencies much more money than the consultants received themselves.

It will be a bit more difficult in those cases where offshore or trust accounts were actually opened. If one assumes that these accounts were indeed not usually in the name of the respective consultant, then it depends on whether or under which conditions money flowed in terms of § 11 Income Tax Code. The reason for this is that consultants usually have to pay tax on income as soon as they have the economic power to dispose of the money. This is the case when the consultant can factually determine what happens to the money. To do this, it is at least essential for him to know about the money at all.

The tax investigations are of the opinion that the consultants disposed of the money at that moment when they instructed the management company to keep the money in a prefix number account.

That is too general. Each individual case will rightly have to be investigated separately. In particular, one can presume that many consultants were by no means aware of the money the agencies received.

Some examples:

1) The consultant A had money for his retirement paid to an account abroad on a regular basis and paid no tax on it.

* In this case, there is obviously the obligation to pay taxes in Germany.

2) Consultant N was paid extra money after termination of his work, in order to tide over temporary unemployment.

* In this case, it can be debated whether the consultant already “disposed” of the money at the time it was paid into a trust account or at the time it was paid out to him. This determines the time of the liability to pay taxes – and, where applicable, the statute of limitations.

3) Consultant X was given a loan.

* In this case, the circumstances of this individual case will have to be considered. It rightly depends on whether the loan was provided at the usual market conditions, i.e. whether there are, for example, clear regulations about credit securities, interest and terms of repayment.

4) Consultant Y was promised orally that money is at his disposal on call. However, he has never seen it. Now, after the allegations against the management companies became public, he was denied payment. There are no agreements in writing.

* If, in this case, one would insinuate that the money that flowed is to be assigned to the consultant as income to be taxed, this would mean that the person concerned would have to pay tax on money he never received.

In reality, sums far exceeding 100,000.00 Euros are often involved. If the tax office were to assert their general suspictions, this could mean the person concerned faces a financial ruin.

III. Criminal law and tax law

Although all cases from the tax office’s point of view initially appear to be similar, from the criminal defence lawyer’s point of view, various constellations have to be differentiated, for each of which a different defence strategy is recommended.

1. The allegations refer to the years prior to 2003

The years in that period are mostly statute-barred. In such a case, one can only expect supplementary tax payments. The tax investigators have only limited possibilities to enforce the obtainment of information. House searches in particular can be eliminated as a means of obtaining information

In this context, the question is often raised whether the tax payer is obliged to co-operate (particularly in accordance with § 90 II Fiscal Code due to circumstances with a foreign element. Furthermore, it can be debated under which conditions the tax office has the possibility of issuing estimated tax statements (§ 162 Fiscal Code).

For those concerned, who are now living abroad again, the question arises whether there is a danger that their money – either saved in Germany or abroad – could be “frozen”. The penal basics that permit money to be frozen (§§ 111b ff. German Code on Criminal Procedure) certainly does not apply in this constellation. There is no known case where the tax office has made use of the possibility of freezing available monetary assets according to § 324 Fiscal Code.

2. The allegations refer to the years from 2003 until today

This period is not statue-barred neither in terms of criminal law or fiscal law.

In this case, the focus of the defence rests on the question of whether or under what conditions it can be proven that the person concerned actually did receive money via foreign accounts.

No cases have been revealed in which the result was a warrant. Fundamentally speaking, a warrant could be imaginable if, for example, there is the danger that the person concerned could abscond criminal proceedings by moving abroad. The issuing of a warrant, however, is likely to be in no relation to the large number of open tax issues.

Even freezing available assets in Germany can be considered (“warrant against money”). The legal basis for this can be criminal law (§§ 111 b ff. German Code on Criminal Procedure) or the General Fiscal Code (§ 324 Fiscal Code).

A recovery of assets abroad is not fundamentally impossible, yet in practice, tax investigators continue to reach their limits. By means of various international agreements and decisions, legislation is working towards co-operation on an international level being more effective in the future.

3. Periods for which no tax declaration has been submitted

In this case, it is necessary to act fast. It must be examined whether the submission of ongoing declarations will create new criminal liabilities.

IV. Self indictment

In order to avoid criminal proceedings, it is possible to submit an voluntary self declaration in line with § 371 Fiscal Code. A person, who has income in offshore accounts and provides proof of this to the tax authorities, has the chance of evading punishment. However, a requirement to do this is that all taxes incurred are paid in full within relatively short periods. This possibility exists irrespective of the amount of tax owed.

A requirement for avoiding penal proceedings for tax evasion or other tax offences is that the offence had not been discovered at the time of amending the return. This issue should be checked carefully before submitting an amended return. At present, one can presume that there are still thousands of cases throughout Germany that are being handled by the tax authorities.

V. Links—hope-for-freelance-contractors.aspx

7. Intentional tax evasion?

However, the initiation of an investigation does not mean that those affected by it will actually be convicted. Because even if objectively the offence of tax evasion by Cum-Ex transactions is fulfilled, this does not automatically lead to a punishment. As with any other offence, tax evasion also includes the so-called subjective offence. This means that the perpetrator can only be punished if he can be proven to have acted intentionally. Intent means that the offender has deliberately committed the offence in full knowledge of all its objective characteristics.

In the transactions surrounding the dividend record date, there are clear doubts about the intention of the participants. Firstly, the business model was so widespread that even the Federal Fiscal Court in its decision of April 2014 spoke of “widely accepted practice”. The extent to which the parties involved actually assumed that they were settling a completely legal transaction under tax law is a question that must be carefully examined for each individual case. There is certainly defence potential here.

Especially for the smaller investor, there is the possibility of invoking an error according to § 17 StGB as a further “lifeline”. The provision applies if the perpetrator lacks the insight to do wrong during the commission of the offence. This is particularly important for investors who have received expert advice before the transactions were settled. After the “tax saving model” was widespread and discussed, an investor who refers to the advice of his (tax) advisor cannot be accused of criminal law.

8. Witness or accused?

A not to be underestimated danger exists for investors, who are to testify as witnesses against the large investment companies. Because precisely because it is not clear how much their contribution to the crime is to be assessed, there is the danger of “talking one’s head off” in such a procedure. Anyone who is to testify in such criminal proceedings and has previously participated in a cum-ex transaction as a holder of securities is therefore well advised to seek independent expert advice before testifying in order to avoid suddenly becoming a defendant in an investigation.

9. Upshot

Many voices have considered Cum-Ex transactions to be completely legal and the initiation of criminal investigations highly unlikely or even absurd. Critical speeches were not taken seriously – cries of protest! The initiation of criminal investigations, as has been pointed out, is by no means as absurd as it was previously claimed. Because one has to admit that the billion-dollar business is clearly at the expense of the tax authorities. All parties involved were aware that only a clumsy legal situation and regulatory gap had been exploited. But precisely because the legal structure is so controversial, there is a lot of room for argumentation and negotiation for prosecutions under fiscal criminal law.