Tax Break

John Fisher, international tax consultant

Archive for the category “Israel”

To tax or not to tax…..

It all makes sense to him

Forced to summarize Israel’s international tax legislation in half a sentence, I could not better Shakespeare’s all time bogeyman – Richard III:  

“Deformed, unfinished, sent before my time/ Into this breathing world, scarce half made up”.

Tax legislation in the first half-century following Israel’s independence adopted, what might now be termed, the “Mitt Romney Approach” –  inconsistent but pragmatic. At a time when citizens were largely barred from investing abroad, work income and capital gains were charged to tax on a worldwide basis while income such as dividends, interest and royalties from abroad were, in practice, exempt.

Then, following liberalization of exchange controls and serious personal and corporate investment abroad in the late 1990s, legislation passed the Knesset in mid-2002  moving Israel to a pure worldwide basis of taxation with effect from January 2003.  This almost pedestrian approach to enforcing the new law – allowing around six months to get organized –  was, and is, in contrast to the normally frenetic approach  adopted by the Knesset, Israel’s parliament, which regularly enforces  legislation almost overnight (and, sometimes, the previous night or earlier).

This may explain the remarkably naive stance adopted by certain respected tax advisors at the time, who insisted, to the horror of the more worldly among us, to advertise their prowess at every opportunity in the national  press, explaining the broad (but, rarely, precise) methods to legally circumvent the new regime.

While the income tax authorities could (and can)  be accused of many things, illiteracy is not one of them and, lo and behold, they managed to fit the art of newspaper reading  into their busy schedules. It was therefore little surprise to the mature and experienced when, prior to enforcement of the new law, an amendment to the amendment was passed in the Knesset to close the loopholes that had been so altruistically revealed by our fellow professionals.

But, as Hamlet (topically since Israel has just ratified a new double taxation treaty with Denmark) said – “Aye, there’s the rub”. 

The authorities were in such a rush to get the legislation passed ahead of the January 1 deadline that the adjustment left much to be desired ( for them, if not for the rest of us). To add to the misery that awaited them, they had insisted in going it alone with the legislation. They had neither canvassed extensive public comment nor, apparently, recognized that, not being the first, second or fiftieth nation on earth to adopt a worldwide basis of taxation, it might be wise to benefit from the learning curves of others rather than starting from scratch.

The result was : a flawed system of credit for foreign taxes paid; ambiguous controlled foreign corporation rules, the latest explanatory notes in respect of which came out only a month ago – nine years after the legislation came into effect; a participation exemption regime that  literally exempted almost everyone from participation and, from day one, was treated as if it had leprosy; and a tax-transparent company system that has transparently gone nowhere. We were subsequently introduced to Trust-Nobody Trust rules in 2006 and, two years later, the Worldwide Untax Regime for new immigrants and returning residents.

While this blog will endeavor to maintain a truly international flavor, I make no apology for including from time-to-time in the weeks and months ahead, reflections on the system with which I have an “up close and personal” relationship. At the end of the day there is much more that unites countries in their international taxation rules than divides them and I hope those reflections are of interest to everyone.

Amnesty International

English: United States Internal Revenue Servic...

Image via Wikipedia

The casual observer may be forgiven for thinking that last month’s announcement by the Israeli Income Tax Authorities of a  new amnesty  program for foreign undeclared income was motivated by the realization that if – as the US authorities close in on tax evaders – Israel does not act fast, all the “captured” tax of US citizens living in Israel will flow into the coffers of the US Treasury.

 

Back in 2005 the ITA started a Voluntary Disclosure Program to enable Israeli tax residents to come clean on their undeclared income. The scheme, which was open-ended,  offered immunity from criminal prosecution but not much else. The announcement in November 2011 that Israeli residents coming forward by the end of June 2012 could hope to pay the tax, without interest or penalties, on undeclared foreign income was a far more tempting proposition.

The conditions under which the foreign undeclared income is eligible for the amnesty, beyond the requirement that the applicant has broadly not been caught red-handed,  are flexible – but the sample list given by the ITA provides an indication as to the  extent that this was aimed at immigrants: undeclared income from foreign assets inherited from, or gifted by,  a foreign resident; undeclared income from foreign assets that were purchased using funds that arose from income taxed in Israel or income that was not liable to tax in Israel; and undeclared income from foreign assets that only became liable to tax from 2003 when the Israeli system moved from a largely territorial basis to a worldwide basis. 

Remembering that  Israeli-born residents were heavily restricted in their ability to invest legally abroad until the end of the last century, the bias towards Olim from “Western Countries” (which is a euphemism for the US, since the English, French, Canadians and others are just a statistical error in the ITA’s worldview of lost tax) is obvious.

Now that the IRS has won the battle in Switzerland and  should  soon finish bayoneting the wounded, it is widely rumored that the next stop on its tax-grabbing crusade will be the Holy Land. Hence,  the timing could not be better for the ITA to step in and suggest that people pay up in Israel, which in most cases has the first right to tax. This may have a mitigating effect on subsequent disclosure to the IRS, given its newly instituted softer approach to dual citizens (see earlier post), especially where they have declared the income abroad – but it is too early  in the day to draw any firm conclusions.

The potential downside in the whole affair is that any application under the amnesty is to be considered by a Star Chamber of senior income tax officials. There is a promise  that, even if an application is rejected,  the facts will not be used in evidence elsewhere.

When I read this, it reminded me of my first year in High School. There was a particular teacher who had an unfortunate habit of boxing pupils around the ears (which, judging by his level of intelligence, is probably what happened to him as a child). We quickly learned, as he approached, to raise our hands to cover our heads. He would then go through the standard ritual (which took longer each time, as the months rolled by) of telling a poor victim to put his hands down because he was not going to hit him; I do not need to finish the story.

However,  in practice, it seems that it may be possible to initially present the facts to the ITA anonymously and only name names when it is fairly apparent that the application will be accepted.

Overall, these are interesting times for people who have undeclared income and there is a window of opportunity that  could be, for many, the Last Chance at the OK Corral.

The best of times, the worst of times

As 2011 prepares to hang up its boots,  closure is finally coming to one of the finest specimens of legislative panic in recent Israeli history.  With the coalition government resembling  a concoction of weird and wonderful characters from the Complete Works of Charles Dickens and the middle-classes appealing “Please sir, we want some more”, the stage was set  mid-year for a roller coaster autumn full of surprise twists and turns.

 Following a summer of social protest  over the lack of economic fairness in the country and formation of a committee to recommend ways to back out of the “No Thoroughfare” , early fears of a politically motivated Estate Tax – always more of a rabble pacifier than a revenue earner –  gradually abated.  Then there was the proposal to apply a 2% “supertax” on the wealthy which fell off a cliff at the last moment (but might experience one of those miraculous literary recoveries and come climbing back up next year).  Meanwhile, lurking in the background was the perennial  threat of a National Insurance hike: we had already experienced the temporary doubling of the National Insurance  ceiling which followed, about a decade ago, the temporary total cancellation of the National Insurance ceiling which had meant at the time a whopping effective top marginal tax rate of 67%.

The amazing thing, however, is that what finally got thrown up, whether you agree with it or not, makes sense – like the unusually tidy endings of Dickens’s Christmas stories.

The marginal tax rate came to rest at 48% – a clear statement of policy that individuals should be left with more than half their income in their hands (until the government decides otherwise); national insurance was put back in its traditional box with its traditional ceiling; tax on passive income was hiked from 20/25% to 25/30%. What is more, it was not an immediate knee-jerk, but imposed from January 2012 giving taxpayers the chance to sensibly plan the transition – including dividends at the 25% rate in 2011 as well as 2011 bonuses and the theoretical sale of assets – although time is fast running out.

 

Of course, being Israel, not everything has gone totally smoothly. While legislation raising the tax on passive income has passed, the tax authorities and legislature seem to be struggling with the updating of Regulations which, given that they basically involve the crossing out of one tax rate and replacement with another, could be done by a five year old with a spirograph. This means, for example, that unless the  authorities get their act together by the end of this week, public companies paying a dividend in January 2012 face the dilemma of whether to deduct the new rate at source (which is the recipient’s tax liability) or follow the existing  Regulation for tax deduction that has not yet been updated and leave the recipient with the obligation to file a tax return (which, in the case of foreign resident recipients is normally a theoretical point).

 

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