Definition and Nature of Valuation Discretion
Valuation discretion is a central principle in German law, particularly in tax law and civil law, and describes the freedom of decision-makers to exercise their own decision-making leeway when assessing circumstances within the framework of judgments (valuations, estimates, forecasts). Valuation discretion limits the extent to which such judgments can be reviewed by courts and authorities, as valuations fundamentally rely on subjective assessments and expert evaluations and therefore cannot be assessed solely based on rigid, objective criteria.
Valuation discretion is distinct from discretion (Ermessen) and mandatory decisions in that it not only permits a legal judgment, but also involves an actual assessment of facts.
Legal Dogmatic Foundations
Distinction from Discretionary Power and Determination of Facts
Valuation discretion refers to the assessment of facts, as opposed to the determination of facts itself, which is subject to full judicial review. It differs from discretion in that the latter involves choosing between several legally permissible options, whereas valuation discretion allows the interpretation and weighting of specific facts or economic occurrences.
Constitutional Foundation
Valuation discretion can be derived from the rule of law principle (Art. 20 para. 3 Basic Law), as well as from the principle of the reservation of law and the separation of powers. It ensures that specialized decision-makers can freely and appropriately assess complex situations without courts or supervisory authorities imposing their own valuations.
Valuation Discretion in Tax Law
Principle and Areas of Application
In tax law, valuation discretion is of particular importance, such as in the accounting and valuation of assets (§§ 5, 6 EStG) or in determining market values for tax purposes (§ 194 BauGB). Taxpayers have, within the limits set by law (e.g., valuation regulations, generally accepted accounting principles), a margin of discretion regarding estimates, fair value approaches, or the probability of value developments.
Limitations and Restrictions
Valuation discretion ends where statutory valuation standards are mandatory or the discretionary selection (e.g., through simplified valuations or valuation discounts) is restricted. Moreover, it only exists as long as the valuation decision does not clearly contravene legal norms (prohibition of arbitrariness, principle of relevance) or the principle of good faith (§ 242 BGB).
Case Law on Valuation Discretion
Case law particularly recognizes valuation discretion regarding the extent to which valuations in the determination of income within the framework of proper accounting or statutory valuation methods are subject to discretion (see BFH, judgment of 8 November 1960 – I 352/59 U; BVerwG, judgment of 19 February 1963 – I C 127.61).
Valuation Discretion in Civil Law
Valuation Discretion in Value Judgments and Forecasts
In civil law, valuation discretion particularly concerns the assessment of performance disruptions, the extent of damages, or a reasonable effort for performance. It applies, for example, when determining the appropriateness of deadlines, claims for compensation, or withdrawal rights.
Distinction Between Mandatory Decisions and Discretion in Valuation
The margin of discretion in civil law differs from mandatory decisions, which are determined by fixed norms, and applies to value judgments, forecasts and probability assumptions. Courts only examine whether the assessment was appropriate and coherent, but not the concrete valuation itself.
Valuation Discretion in Other Areas
Administrative Law
In administrative law, valuation discretion often appears when assessing suitability, competence, and professional performance in the course of selection decisions (e.g., assessments under civil service law). There is also a margin of discretion when assessing reliability or forecasting danger in security-related proceedings.
Competition and Procurement Law
In competition law and procurement law, valuation discretion plays a role when setting criteria and weightings for the evaluation of offers. Judicial review is limited to breaches of evaluation criteria or obvious errors in valuation.
Control and Reviewability of Valuation Discretion
Limits of Judicial Review
Courts review valuation decisions only to determine whether they were made professionally, without arbitrariness, and in compliance with procedural regulations (so-called “evidence control”). Courts generally do not substitute their own substantive assessment.
Abuse and Correction of Errors
If valuation decisions have been made incorrectly, unreasonably, inconsistently, or for irrelevant reasons, a correction or annulment may occur. The review particularly extends to compliance with statutory and methodological requirements as well as the coherence and traceability of the valuation process.
Summary and Importance
Valuation discretion is an important margin for decision-making in German law and complements other forms of decision-making, such as discretion, by enabling the free assessment of facts. It ensures the adaptability of the law to complex factual and valuation situations and limits governmental and judicial intervention to cases of obvious valuation errors. Valuation discretion is thus a significant principle that safeguards expert and flexible decisions and contributes substantially to the functionality of the legal and administrative systems.
See also:
Legal Sources and Further Reading:
- Income Tax Act (EStG)
- Valuation Act (BewG)
- German Civil Code (BGB), in particular §§ 242, 249 ff.
- Federal Administrative Court, Judgment of 19.02.1963 – I C 127.61
- Federal Fiscal Court, Judgment of 08.11.1960 – I 352/59 U
Frequently Asked Questions
Can valuation approaches in the balance sheet be chosen freely, or are there statutory requirements?
In a legal context, valuation discretion in the balance sheet is restricted by numerous statutory requirements and frameworks. In principle, the German Commercial Code (HGB) and, where applicable, international accounting standards (such as IFRS) regulate the permissible valuation methods. Companies do have certain options within defined limits (for example, valuing inventories using FIFO or LIFO, where permitted), but they are obliged to observe the principles of proper accounting (GoB), in particular the principles of clarity and truthfulness as well as the principle of prudence. Legal requirements also determine for certain assets and liabilities how they must be valued (e.g., the valuation of fixed assets at acquisition or production cost less depreciation as per § 253 HGB). Thus, valuation discretion is particularly limited by mandatory valuation criteria and restrictions in commercial or tax law, meaning there is no absolute right of free choice.
To what extent does tax law play a role in valuation discretion?
Tax law has a significant impact on valuation discretion, particularly through the principle of relevance (§ 5 para. 1 EStG), according to which valuations made in the commercial balance sheet are fundamentally also authoritative for the tax balance sheet. However, there are explicit tax regulations that deviate from the rules under commercial law and must be observed, such as the lower-of-cost-or-market principle (§ 6 para. 1 no. 2 EStG) or special depreciation rules. These tax provisions further restrict the scope permitted under commercial law. Permissible commercial law options do not always have to be adopted for tax purposes; conversely, tax regulations may impose stricter or different valuation criteria, thus further limiting or influencing accounting valuation discretion.
What penalties can arise from violations of valuation rules?
Violations of statutory valuation rules can have severe legal consequences. Initially, civil liability claims may be brought by shareholders, creditors, or other stakeholders if a violation can be shown to have caused erroneous decisions. Especially serious are violations that result in a misrepresentation of the asset, financial, or earnings situation (§ 264 para. 2 HGB). In such cases, the responsible managing director or board member may be criminally liable under § 331 HGB or § 400 AktG — this may include imprisonment or substantial fines in the most severe cases. In addition, tax assessment and criminal proceedings may be initiated if incorrect valuations result in tax evasion. Finally, there is the risk that financial statements may not be certified by auditors, which can have serious economic repercussions.
Are there differences in valuation discretion between small and large companies?
The legislator distinguishes between companies of different size classes (micro, small, medium, and large enterprises) in commercial law (particularly the HGB). These classifications affect valuation rules and the exercise of options. Smaller companies benefit from simplifications, such as the option to forego the preparation of notes or management reports (§§ 266 ff. HGB), and in some cases may use simplified valuation methods. However, there are also minimum requirements for them, particularly when determining annual profit. For large companies, there are often more detailed and stricter requirements regarding documentation, valuation standards, and disclosure. As a result, statutory valuation discretion is generally more limited for large companies than for small ones.
What is the significance of the principle of prudence for valuation discretion?
The principle of prudence (§ 252 para. 1 no. 4 HGB) is one of the most important regulatory principles in accounting law and significantly limits valuation discretion. It requires restraint in valuations, meaning that income may only be recognized when realized, while losses and risks must be accounted for as soon as they become apparent. In other words, in cases of doubt, the value assumption less favorable to the company must be chosen. The principle of prudence therefore significantly restricts management’s freedom in valuation and protects creditors and investors from overly optimistic balance sheet statements and associated risks.
What reporting obligations exist in connection with valuation decisions?
Valuation decisions based on commercial or tax law options are often associated with special reporting obligations. In the notes to the financial statements (§§ 284 ff. HGB), companies often have to disclose the accounting and valuation methods applied and explain any changes compared to the previous year, as well as their effects on the asset, financial, and earnings position. Moreover, disclosure of discretionary decisions and estimates may be required in certain cases, especially if they significantly affect the company’s presentation. This reporting ensures transparency for financial statement recipients and the comprehensibility of the exercise of (limited) valuation discretion.
