ESFP and tax audit of an individual

Under the third paragraph of Article L. 16 of the French Tax Procedure Code (Livre des Procédures Fiscales, LPF), tax inspectors enjoy very broad latitude in the course of their various investigations.

These most often concern the bank accounts and similar accounts of an individual taxpayer, during the examination of his or her personal tax situation (examen de la situation fiscale personnelle), known as the ESFP.

In this very particular context, it is essential to understand the ins and outs of an audit that may have significant, or even very significant, consequences for your assets.

Which situations should be avoided, and how can a potential reassessment be countered?

The specific framework of the ESFP: what are the risks?

This examination, which is in fact a tax audit, triggers a procedure that allows the inspector to verify and analyse the bank accounts of the taxpayer subject to the procedure.

It is an audit whose purpose is to verify the consistency between the income declared and the taxpayer’s financial situation. It is also a means of comparing the taxpayer’s cash position with his or her lifestyle and that of the other members of the tax household. In this context, the inspector reviews all documents relating to bank transactions, such as the taxpayer’s receipts and payments, which can be consulted on the account statements.

Where the report reveals inconsistent bank credits, the tax authorities (administration fiscale) may send you a request asking you to provide clarifications, or even justifications, regarding these amounts. If you do not respond to this request, an ex officio assessment procedure (taxation d’office) may be applied. However, for this request to be validly addressed to the taxpayer, the bank account must show amounts at least twice as high as the declared income. In this specific case, this is the rule commonly referred to as the “double rule”, which is immediately understandable. The second case that may lead to an in-depth examination of the personal tax situation (examen contradictoire de la situation fiscale personnelle) arises from a discrepancy exceeding €150,000 with the declared income. Nevertheless, in principle, in certain cases, the audited taxpayer does not have to explain the nature of the bank credits appearing on his or her accounts where these do not show such discrepancies.

The situations that generally attract the particular interest of the tax authorities are the following:

● Mixed accounts: these are accounts used both as private and business accounts. Where the ESFP reveals an omission or an insufficient declaration, the tax authorities may issue a reassessment. It should be noted that this audit may be carried out without falling within the specific framework of an audit of the business’s accounts. Consequently, it is strongly discouraged to use this type of mixed account for your business cash. On the contrary, it is recommended to separate private cash and business activity as far as possible, for example by using a business account for your business transactions.

● When you hold an inactive account: this situation can lead to surprising outcomes. First of all, an account is in principle declared inactive at the end of a year during which the account holder has not made any transaction. If you hold one, you have no doubt noticed that the bank starts charging fees for inactive accounts. These dormant accounts, which sometimes hold substantial sums, may alert the tax authorities and lead to an ESFP procedure. The audit takes place at the tax office or, at the taxpayer’s request, at his or her home.

● When your bank account regularly records cash deposits, for amounts that are ultimately significant

● When your bank account has received sums from abroad, for significant amounts

● When you have made transfers abroad for significant amounts

● When you hold one or more undeclared foreign accounts

● When your lifestyle appears significantly out of line with your declared income: for example, the purchase of real estate without a loan for a large amount while declared income is low, the creation of a company with substantial capital while declared income is low, ownership of several high-end vehicles while declared income is low, etc.

It is preferable to avoid these situations, which are often the cause of an in-depth audit by the tax authorities. With regard to so-called “dormant” accounts, specific legislation has existed since 1 January 2016 authorising searches for the holders of these accounts. This legislation enables them to avoid the outright closure of their account, or even to recover the sums held in it. It also serves to trace deceased persons who still have existing assets.

The ESFP procedure in detail

While the taxpayer subject to an in-depth examination of his or her tax situation benefits from specific safeguards, he or she is also bound by certain obligations. In particular, the taxpayer must answer the questions that the inspector may send to you in writing.

These concern the precise origin and nature of the amounts shown in your accounts. You must justify them for all the years covered by the examination. This request is made by means of a request for justifications (demande de justifications) no. 2172-SD. It is very demanding, since the tax inspector may require you to produce convincing and sufficiently explanatory clarifications and supporting documents regarding the transactions recorded as credits in your cash accounts. To do so, the inspector may use the two frameworks mentioned above, which fall under the third paragraph of Article L. 16 of the LPF, or French Tax Procedure Code:
• The inspector may rely on the fairly old rule known as the “double rule“. As explained above, this is the possibility of questioning you if the total amount credited to your personal bank accounts is at least equal to twice your declared income. This applies for each year audited.
• Since 1 January 2013, the inspector may also send you a request for clarification where the total amount of your bank credits exceeds your declared income by at least €150,000.
In both of these scenarios, and in response to request for justifications no. 2172-SD, you are required to provide a set of material evidence justifying the exact origin of the sums credited to all your bank and similar accounts.
On the other hand, the tax authorities cannot in principle take any truly binding measure against you if neither of the two cases is established. The provisions of the third paragraph of Article L. 16 of the LPF do not then apply to your tax situation. You indeed benefit from safeguards in this procedure, and any breach of them could result in the annulment of the procedure and of the reassessment to which the inspector has subjected you.
More specifically, if the tax authorities, through their inspector, pursue the ESFP procedure by requiring justifications for the years concerned, your tax lawyer handling the defence of the case may have it declared inadmissible.

What should you do when your tax situation falls within one of the two frameworks above?

If, on the contrary, you fall within one or the other of the frameworks described, you have a period of two months, as provided in Article L. 16 A of the LPF, to gather and provide as many justifications as possible.
It is during the preparation of these files, which are essential to avoid the reassessment with which the inspector is threatening you, that the role of the tax lawyer comes fully into its own. As is often the case, certain transactions made on your account did not give rise to supporting documents, whether transfers from one account to another, loans to a third party or to a family member, or the sale of personal property or vehicles. You may be unable to prove the origin of certain payments credited to your bank accounts. You should then be aware that, under Article L. 69 of the LPF, you are liable to an ex officio assessment (taxation d’office) to income tax and social security contributions (prélèvements sociaux) if you do not provide sufficiently convincing answers to justify these transactions. Your tax lawyer is at your side to support you in this work of collecting data and evidence. He supervises these often very tedious steps in order to provide you with the most convincing documents for the tax authorities.
Be aware, however, that where official documents are lacking, you may gather a range of miscellaneous documents in order to persuade the tax authorities of your good faith. These acknowledgements of debt, sworn statements and various invoices tend to show that you have not carried on a concealed profit-making activity.

All this evidence serves to support your defence and to facilitate comparisons with the bank statements that show inconsistencies. It is obviously advisable to gather all the elements relating to non-taxable transactions.
Once these supporting documents have been added to your file, the inspector may consider them insufficient. The inspector is then required to grant you an additional period of one month so that you can put together a more complete set of explanations. All these safeguards are inalienable and can be consulted in the French Tax Procedure Code. They protect you against any pressure from the inspector. Your tax lawyer knows all the subtleties of these legal texts so that you can take full advantage of them.

The firm’s commitment to assist you in this specific context

With a thorough command of the ESFP procedure, your tax lawyer is able to guide you effectively through all the stages of your examination. Upstream, as soon as you become the subject of an examination procedure, to tell you whether you may be subject to a reassessment in light of your bank assets. Further on, to gather and put together files containing supporting documents that match the payments and meet the inspector’s expectations. Finally, to defend your rights should you be subjected to pressure and should your legitimate safeguards not be respected. By turning to a tax law specialist, you put every advantage on your side to face this ordeal in the best possible conditions.