Understatement or evasion of tax: what is the difference – and why does it matter so much?

Key takeaways

• Tax evasion (Steuerhinterziehung) exists where tax is intentionally assessed too low or not paid; a reckless understatement of tax (leichtfertige Steuerverkürzung) rests on gross carelessness without any intention.
• Tax evasion carries fines or custodial sentences, a reckless understatement an administrative fine – the payment of the tax and interest affects you in both cases.
• In many proceedings the allegation of tax evasion can, with the right argument, be limited to a reckless understatement, which considerably reduces the risk of a penalty.

I. How do tax evasion and understatement of tax differ?

The essential difference between tax evasion and a reckless understatement of tax does not lie in the fact that too little tax was ultimately assessed – that result is the same in both cases. What is decisive is rather the state of mind in which the person concerned acted. In the case of tax evasion, the tax office is deliberately deceived or left in the dark about material facts in order to avoid tax knowingly. In the case of a reckless understatement, that intention is absent; here someone acts far too carelessly, taking their tax obligations "too lightly", but does not set out to evade tax. This inner difference – intent on the one hand, gross negligence on the other – determines whether there is a criminal offence or "merely" an administrative offence, with correspondingly different legal consequences.

One speaks of tax evasion where incorrect or incomplete statements are knowingly made to the tax office or facts of tax relevance are concealed. Typically, income is deliberately not declared – for example rental income, fees or foreign interest – although the person concerned knows perfectly well that it is taxable. Frequently, private expenses such as holidays, clothing or private vehicles are also deliberately claimed as business expenses or income-related expenses, although it is clear to the taxpayer that these costs are privately motivated and therefore should not be deductible for tax purposes. In such cases the aim is evidently to avoid or reduce tax deliberately.

By contrast, a reckless understatement of tax – often referred to simply as an "understatement" – involves no intention to deceive, but gross negligence. The person concerned takes their obligations towards the tax office far too lightly, without setting out to evade tax. Typical situations are that important information is overlooked, documents are submitted incompletely, or a tax return prepared by a third party is not read through carefully again although this would have been possible without much effort. Frequently the taxpayer relies uncritically on documents that are obviously incomplete, or dispenses with a plausibility check although there are clear indications of inconsistencies. Intent is therefore absent, but the duty of care is breached to a considerable degree.

Put very simply: anyone who acts intentionally commits tax evasion – that is a criminal offence. Anyone who acts "only" with gross negligence commits a reckless understatement of tax – that is an administrative offence, therefore not a criminal offence, but nevertheless associated with noticeable financial and possibly also professional consequences.

In investigations and court proceedings the issue is very frequently precisely this distinction: could the person concerned have recognised that their statements were incorrect, and did they knowingly accept this – or were they merely far too careless?

II. How do the consequences of tax evasion and of understatement differ?

Tax evasion and understatement of tax differ as regards the penalty. In both cases the tax not paid has to be paid subsequently. Interest is also payable on the unpaid tax. That interest amounts to 6 % per year. Late payment penalties also arise where tax has not been paid. There are differences, however, as regards the further sanctions:

• Tax evasion (criminal offence): Tax evasion is a criminal offence. A fine or a custodial sentence of up to 5 years is accordingly in prospect. In particularly serious cases a custodial sentence of up to 10 years is even possible. The precise penalty depends on the specific circumstances (for example the extent of the tax evaded, existing previous convictions, and so on). As a general rule, from EUR 100,000 of evaded tax there is a high risk of a custodial sentence. Alongside the loss of liberty, a custodial sentence has further disadvantages: there is a risk of losing one's job or other permits (for example a trade licence or a hunting licence). 
• Reckless understatement of tax (administrative offence): This is not a criminal offence but less serious misconduct resting on gross carelessness – that is, someone taking their tax obligations far too lightly without setting out to evade tax. Instead of a fine or custodial sentence, an administrative fine is imposed, payable in a single sum or in instalments. A custodial sentence is excluded; there is therefore no prison, but "merely" an administrative fine. There is no criminal conviction and therefore no entry in the certificate of good conduct; in law you are not regarded as having a criminal record.

For many of those affected, what is decisive is less the amount of the payment than the question whether they end up with a criminal record or whether "only" administrative fine proceedings are concluded.

III. Can tax evasion be "converted" into an understatement?

The legal classification is not fixed from the outset. In many cases it can be achieved in the course of the proceedings that an allegation of tax evasion becomes a reckless understatement of tax.

From the perspective of the tax authorities and the public prosecutor, considerable discrepancies initially point strongly to a suspicion of evasion, for example where

• substantial income is missing entirely,
• implausible or obviously non-deductible expenses have been claimed,
• the conduct is repeated over several years.

The defence takes precisely these points as its starting point. It seeks to show step by step that although mistakes were made, there was no deliberate tax evasion. The aim is to make clear that the person concerned misunderstood the tax rules or underestimated their significance and therefore acted only recklessly – that is, with gross carelessness, but without intention.

Typical lines of argument in such proceedings are, for example:

• Complexity of the legal position: The tax provision is so complicated that an average taxpayer can scarcely understand it. That can be the case, for instance, with cross-border matters involving several states. Anyone who makes mistakes here without particular expertise or specialist advice is often not aiming to evade tax but failing in the face of an opaque legal position.
• Advisory and organisational failures: There are organisational problems (for example a change in the accounting function, absences in bookkeeping due to illness, IT migrations or rapid corporate growth) that have favoured errors. In such phases receipts can be left lying, deadlines overlooked or figures transferred incorrectly, without anyone setting out to evade tax.
• Absence of concealment measures: There are no indications of receipts being deliberately hidden, no parallel "black" cash boxes and no targeted acts of deception. The documents are in principle available and can be located, entries are not systematically manipulated, and there are no arrangements to route income deliberately "past the books". Instead, much points to an unstructured or careless way of working rather than to planned concealment. 

The aim of these defence strategies is to reduce the allegation from a criminal offence (with a possible custodial sentence) to an administrative offence with a fine. That changes the legal assessment and the practical consequences considerably.

IV. What does "recklessness" actually mean – and how does it differ from intent?

A person acts recklessly where they clearly and recognisably disregard important duties of care – for instance by overlooking obvious errors although they could have been noticed at a glance. It is therefore a heightened degree of negligence. 

Intent, by contrast, exists where the person concerned knows that their statements are incorrect and nevertheless at least accepts this in order to save tax. 

An example: you forgot a small secondary activity on one occasion because you had to sort through many different documents – that points to recklessness. It is different where you deliberately fail to declare certain income every year in order to save tax – that points rather to intent and therefore to tax evasion.