Tax Break

John Fisher, international tax consultant

Archive for the month “February, 2020”

The People’s Court

Who dunnit?

This year marks the 50th anniversary of the first performance of the classic satirical farce ‘Accidental Death of an Anarchist’, in which two policeman under investigation for the death of a suspect in their custody weave a web of increasingly improbable explanations as to how he fell out of the interrogation room window.

I don’t know what just made me think (nostalgically) of the play, but there was a Tel Aviv District Court decision about 10 days ago that, quite coincidentally, brought a coast to coast smile to my wizened face.

It is actually an old story, originating with a decision by the same judge in 2016 that, on appeal, was ping-ponged back to him for further thought by the High Court . Well, he thought again and spent 63 pages sharing those thoughts, coming to the same conclusion as the first time – the little man was right, and the tax authorities were wrong.

To cut to the chase, the case involved a group of investors who jointly held shares through a foreign holding company (in fact, two foreign holding companies, but let’s not confuse ourselves with irrelevant facts) in a foreign trading company that eventually went public. The foreign holding company was in one of those fungible, fun exotic getaways – The Turks and Caicos Islands, completing a structure that was popular at the time of the company’s creation before Israel abandoned its territorial basis of taxation in 2003.

In case you haven’t seen one.

Stuck with a Doctor Dolittle Pushmi-Pullyu situation, where shareholders had to effectively sell shares in the traded company together via the holding company, their accountant approached the Israeli tax authority to rule that shares of the trading company transferred to the individual shareholders would only be taxable on their sale. The guys at the tax authority were willing to listen. They accepted that the holding company was merely a conduit for the ultimate shareholders and came up with a ruling that accepted the request with the proviso that, if the shares were not sold by a certain date, the tax charge – defined as a dividend from the holding company – would crystalize at that date.  A month later, ostensibly because not all the shareholders had signed on the agreement (quite probably due to tax authority bureaucracy), the tax authority cancelled the deal. They might have cancelled the deal for the more convincing reason that they had no right to make it in the first place – conduit companies are extremely specific in Israeli law, and none of those specifics apply to this case – but, they didn’t.

By the time the  ‘Dear John’ letter from the tax authority  had arrived on the shareholders’ doorstep, they had already organized the transfer of shares resulting in a whopping great tax bill on the deemed dividend from the holding company, setting the scene for a whopping great court case.

Another moonlighting accountant

To complicate matters, while all this was happening the shareholders changed horses, or at least accountants, mid-stream. Their new advisor advised them that it looked to him like the shares were in fact held in trust by the holding company, so there should be no tax until sale even without the tax authority’s benevolence. Apparently concurrent with this dazzling epiphany – hey presto – a Swiss lawyer came yodeling over the alps with an undated Fiduciary Agreement (trust agreement), the date of which could only be verified by reference to a fax machine’s header imprint on the last page. When the original accountant was asked if a trust arrangement had ever been mentioned to him, he tactfully answered that he did not recall, but – ‘if it walks like a duck, swims like a duck, and quacks like a duck, it is a duck’. A comedian accountant.

The judge came out firing at the tax authority on all cylinders – they should never have cancelled the agreement just because everyone had not yet signed, while this had all the trappings of a genuine trust arrangement – lock stock and barrel. He reinstated the original agreement (rather than going down the trust route), which was all that was being requested (the price of the shares along with the exchange rate had plummeted by the date the agreement required tax to be paid).

It is not clear whether this is going to be ping-ponged back to the High Court – but, inter alia, it raises an interesting question regarding trusts and holding companies. The trust tax law is extremely restrictive as to what qualifies as a transparent holding company in a trust context – only a Trust Assets Holding Company with its draconian conditions. Non-compliance with the terms of the law (which, in the case of older trusts at least, is a matter of fact rather than design) can lead to punitive tax situation. Could this case, despite the specific wording in the law, help widen the definition of ‘transparent’?

In the version of the play that I saw in London in the 1970s, the window was high, and the policemen had to prove that the anarchist had managed to move a table against the wall, place a chair on top, and climb up and out while they had their backs turned. A bit of a stretch, but you never know…

Keeping VAT off the streets

Now, that is tax evasion

When people refer to ‘tax evasion’, they are rarely talking about VAT. The criminal non-payment of VAT, as distinct from its elder siblings – Income Tax and Corporate Tax, is universally known as VAT Fraud. The name reflects none of the grudging respect for the brilliant wheezes of talented white collar crooks . No, sir. While income tax and corporate tax are carefully molded to reflect the sophisticated progressive and tax neutral economic societies they serve, VAT is the thug in the system. Slapped on in all its simplicity with little room for mercy, VAT attracts evaders of the same ilk. VAT fraud – as the blunt name broadcasts – tends to be crude, and its perpetrators often stupid.

Take the most prevalent VAT fraud in the European Union – Carousel Fraud. Products literally continually circulate between countries – an importer pays no VAT, charges VAT on sale and pockets what he receives without reporting it, there are a number of legal ‘buffer’ sales between various parties in the same country culminating in a sale to one of the importer’s accomplices . He makes a sale back to the original country with zero rate VAT and reclaims the VAT paid. That reclaim is the tax authority’s contribution to the fraudsters’ coffers. Then, abracadabra, the whole process can start again. So, how do they get caught? One possibility is catching the fictitious invoice in the books of the purchaser from the importer – but that is a bit hit and miss. The authorities are more likely to strike lucky thanks to a combination of low IQ and complacency on the part of the criminals. Thus, some years ago a gang was caught carouselling  mobile phones (for some reasons mobile phones are a favorite) because they didn’t bother changing the plugs on the chargers when they passed between France and England and back again. Then there was the bunch who realized they didn’t need so many mobile phones, so they filled the top of every box with legitimate items and padded the rest with bricks. And what about the geniuses whose invoices showed them selling the latest iPhone that hadn’t yet hit the market?

He is going to see ‘A Midsummer Night’s Dream’

Slightly cleverer were the Spanish who, a few years back, decided to make use of the differentiated VAT rates in their country. Theatergoers in one, out of the way, town were given, in exchange for their money, a carrot accompanied by a piece of paper with their seat number on it. The carrot was not liable to VAT, while a theater ticket was. There is no record of how many patrons were refused re-entry after a bathroom break in the intermission because they had eaten their proof of purchase.

Well, according to reports, the Israeli tax authorities are about to try something new – prevention in place of detection. If their plans go through, anybody issuing an invoice for more than 5000 shekels (about US$1500) will have to contact the tax authority to receive authority for the transaction, obtaining a unique number to be included on the invoice. That number will be crucial for the recipient to be able to reclaim the VAT. The result is expected to be a dramatic drop in fictitious invoices.

Unfortunately, the plan is also likely to lead to a dramatic drop in economic activity. The other great example of transactions requiring tax authority approval is that of payments abroad that attract withholding tax. The wait for the simplest of transactions can be painful and economically damaging. Business must be allowed to function efficiently. Putting a bureaucrat in the way smacks of the socialist economy this country started out with and jettisoned long ago.

Much more fun for the VAT inspectors, too

If the loss to the nation’s coffers is really the billions the tax authority claim it to be, it makes much more sense to increase the number of VAT inspectors while working towards a system that allows invoice numbers to be paired by computer between seller and buyer untouched by human tax authority hand.

It can only be hoped that street-sense prevails.

Where are the clowns?

Why does she trust him?…

The safety net provided, in varying degrees, by the social security systems of most developed countries is a source of comfort in a changing, uncertain world. However, the recent shenanigans of Israel’s National Insurance Institute, aided and abetted last week by the Tel Aviv Regional Labour Court, makes me feel that we may all be flying the trapeze with nothing but oblivion below.

The Labour Court has just confirmed that the existence of a  Family Company – a hybrid, the tax of which is normally paid by the main shareholder at individual rates, thus neatly skirting Israel’s two tier classical tax system – condemns the taxpayer to national insurance contributions on its entire annual profit. This, despite the fact that had the individual received the income direct, he would not have been liable to national insurance on such income as capital gains and dividends. Although national insurance contributions by individuals are capped, meaning that many will already be paying the maximum irrespective of the family company’s status, that cap is not guaranteed (it has been removed temporarily in the past when the government was short of cash) and, in any event, it interferes with the clear intention of the tax law of tax neutrality on ongoing activities.

No idea…

That last point is a critical one – although social security has its own law, the way contributions are structured around taxable income means that the National Insurance Institute is Robin to The Tax Authority’s Batman, Blair to Bush, Rubble to Flintstone, and Piglet to Pooh. While minor differences are tolerated, even encouraged, teamwork is paramount.

The history of this particular saga suggests that the National Insurance Institute is having something of a teenage crisis, and its guardian – the Labour Court – has inexplicably tried to soothe it, rather than slap it into line.

It all started over a decade ago when there was a badly worded adjustment to the law that led the Institute to take the above approach. However, following protests, they issued a letter in 2015 reversing their position (ie that individuals would only face contributions on those items of family company income that would be taxable if received directly). However – inexplicably – the change of heart would not be retroactive. So, they could still chase earlier years. This ultimately led to the court case mentioned above – brought by 50 aggrieved plaintiffs. But the best bit was that, a few months back, and before the court decision, the Institute announced that it was reversing the 2015 reversal, and from 2018 would be demanding full contributions. ‘SO, THERE! YAH BOO SUCKS!’

The Institute has announced that it will not be pursuing claims for 2015-2017 (perhaps we should be grateful for small mercies). There is a disconnect here in the decision of the court. As has been cited often in court cases, including this one, the fact that a government body has incorrectly applied the law is not a reason – when the mistake is uncovered – to refrain from going after the little man. Yet, the court appeared to agree to the hiatus of 2014 to 2017.

As Sondheim wrote: ‘Send in the clowns. Don’t bother, they’re here.’

Ladies and Gentlemen! Roll up for the appeal!

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