Is the law an ass?
Last Sunday, the High Court clipped the wig of a first-class judge – and the tax community in general – in a landmark decision overturning a lower court’s ruling. It reminded me of the reaction I received from a tax authority official to an article I wrote at the turn of the century for a national newspaper. But first, the case in a nutshell:
It involved the sale by an Israeli company of shares in a foreign subsidiary. With the clearly laudable intention of promoting tax neutrality, Israeli law includes a special provision that treats the capital gain on sale – to the extent there are sufficient accumulated profits in the company sold – to the same tax rate as that applying to dividends. Dividends between Israeli companies are normally exempt from tax, on the grounds that tax has already been paid, so that – while the entire transaction is considered one of capital gain– a portion of the gain is then exempt from tax. Tax neutrality comes in, because there is then no need to reduce taxation by physically distributing a dividend, withdrawing funds from the company that may be economically important to it.
The legal discussion revolved around whether such treatment should be extended to the sale of investments in foreign companies – the relief to taxation not coming from the exemption of intercompany dividends (which only apply within Israel), but rather the availability of a credit for foreign taxes paid which, in this situation, produced the same zero effect.
The lower court took a liberal view, concentrating on the ‘legislature’s intent’, and effectively recognizing that the wording of the law left something to be desired – in layman’s terms, ‘filling in the gaps’. Foreign companies would be included. The higher court was far more prissy. The legislature clearly knew exactly what it was doing, the wording was clear, and the intention of the law was only to achieve tax neutrality in domestic transactions – who gives a fig about international ones?
Quite apart from the hypocrisy of a court that has built up a reputation for waving its gavel at any output of the legislature it doesn’t like the look of, the assumption that the legislature gets tax legislation right simply beggars belief.
Which brings me to that article I mentioned.
There was a piece of new legislation in the early 2000s (ironically, if my memory serves me correctly, it involved investment in foreign shares) that included three sub-paragraphs. Without the absent fourth (it was a question of working backwards) the legislation was without teeth. In my slightly cynical way, I suggested the scene at the meeting of members of the Knesset Finance Committee as they worked into the night to complete the legislation. A senior tax official, drafted in to assist, looked at their watch and gasped. It was 11pm and they had to relieve the babysitter. The meeting came to a quick end, and paragraph 4 was never legislated.
Of course, the entire piece was pure fantasy. The article was duly published in the Business Section of the newspaper’s weekend edition. As the new week began, I received a phone call from a senior tax official: ‘How did you know?’
You couldn’t make it up.
Perhaps because of its complexity, tax legislation is often notoriously incomplete. Thankfully, the tax authority often issues professional circulars, as well as rulings, that attempt to fill in the gaps. Indeed, in the very field of foreign tax credits, I don’t know where we would be without them on such topics as Trusts and Foreign Personal Vocation Companies.
The High Court should be a last resort for sanity. I rest my case.