Tax Break

John Fisher, international tax consultant

Archive for the tag “humor”

What a laugh!


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Don’t mention the war!

The irony of Ukraine’s recent election of a Jewish president would not have been lost on my grandparents who fled the Odessa pogrom of 1905, but they would have been utterly bamboozled – along with millions of members of their grandson’s generation – by the news that he is a satirical comedian.

On the other hand, many would think the contrary – that a honed satirical mind provides the keenest insight into the human condition, the sine qua non for an elected leader.

For someone who has made his living out of speech, President-elect Volodymyr Zelensky was remarkably mute on the issues during the campaign. He was either saving it all up for the ‘opening night’, or – more worryingly – he didn’t have anything to say.

As ‘news’ seeps out about his intentions, it does appear that the new president intends to push ahead with Ukrainian corporate tax reform. As the reform is somewhat revolutionary, it is either a sign of great political courage, or a complete absence of new material in his act.

Volodymyr Zelensky candidate for the post of President of

The polls just kept smiling on him

Despite Zelensky’s media people improbably waving it around as one of his team’s great ideas, the Ukrainian government and parliament have been toying for some time with replacing corporate profits tax (the plain vanilla thing we recognize around the world) with a ‘tax on withdrawn capital’. In a nutshell – companies would not pay corporate tax annually on their ongoing profits, but would incur tax on the withdrawal of any funds. So, for example, dividends  paid to a foreign resident would first attract tax at the company level, that foreign resident picking up  the net dividend as taxable income in  their home country with no credit for the Ukrainian tax paid. This contrasts with the traditional situation, where withholding tax would normally ‘belong’ to the recipient and be creditable in the foreign country either according to domestic law or treaty.

The rationale of the proposal, bantered about by the outgoing administration,  is that the non-taxation of reinvested funds will make Ukrainian industry more competitive. The reality is more likely that it is because tax collection is currently fiendishly difficult, and it will be much easier to collect on a transactional basis when the money is heading out the door anyway. For a courageous newcomer with a proven sense of humor and satirical prowess,  a far superior rationale might bring the house down –  the proposed tax makes more sense than the system employed by the other 190-odd countries in the world.

Although the tax on withdrawn capital is to be imposed on the company, in economic reality it is a tax on the recipient collected through the company – as if an uncreditable withholding tax were imposed on, say, the dividend. The company effectively pays no tax, period.

As I wrote on these pages back in July 2015, it is by no means clear that companies should pay tax.  While Shylock could ask, ‘If you prick us, do we not bleed?’, joint-stock companies – like Pinocchio – do not have the same luxury. Companies are a legal fiction – the Walt Disney of the business world. As they do not have feelings (an accusation often aimed at me), they cannot suffer taxation. Taxation is paid by flesh and blood people – it is the customers who pay higher prices , the shareholders who make lower profits, and the employees who receive lower income. The company just sails on regardless – and, if it dies, does not even warrant a marked grave. There has always, therefore, been a strong movement to abolish company taxes in favour of taxes on individuals – income tax, withholding tax, value added tax. Company taxes, it is argued, distort economic performance.

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Putting Ukraine on the map

There is, of course, one colossal problem with the whole idea – it is nigh impossible to predict annual tax revenues when so much is dependent on the decisions of companies  to distribute, or not. The system has evidently worked in Estonia – a small country – but failed in others. Ukraine is a big country with a complex  economy and a population of over 42 million. It has even won the Eurovision Song Contest twice.

It will be interesting to see if this idea continues its long run, or closes soon after the new leading man takes over.

 

Fishy business

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The good old days…

Among the moral influences on my childhood, and that of my fellow English countrykids, was Hilaire Belloc’s ‘Cautionary Tales for Children’. Entering the Land of Nod at night to the story of Jim who ran away from his nurse and was eaten by a lion, or Matilda who said lies and was burnt to death, none of us was likely to deliver on any 6-year-old’s lurking urge to commit mass murder or rob a bank. Our parents knew how to keep us on the straight and narrow – pure, unadulterated fear.

In a long(ish) career, I have always tried to avoid instilling fear in clients. Clear explanations, and the earning of trust, are usually enough to encourage action. However, there is one area of taxation  in Israel that sometimes demands a little more persuasion when it comes to foreigners, both corporate and individual, setting up businesses here –  professional bookkeeping. And from this month we have a Cautionary Tale all of our own, thanks to a judge in the Tel Aviv District Court.

The judgement reads like a funny children’s book:

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‘101, 102…’

One fine day (that is approximately how the judgement starts) a woman walked into the local fishmonger operated by a Mr Katzav (Google translate: Mr Butcher). It seems they had an argument about the price (he wanted 108 shekels and she was only willing to pay 103 shekels). She ultimately insisted on paying him in notes and coins of small denominations, and stormed out of the shop. Waiting in the street were two comically ill-prepared tax inspectors who were there on a tip-off. They converged on the woman, in sight  – through the window – of a clueless Mr Butcher, and managed with difficulty to extract from her the details of her purchase. Thanks to nobody keeping proper track of what happened next (maybe no fewer than 3 inspectors are needed for that), there was some dispute as to whether the inspectors entered the shop 2 minutes or 10 minutes after the customer left. There was also some confusion as to whether Mr Butcher was on the telephone when they came in, and whether Mr Butcher decided to ring up the purchase (the cash was already in the till) just before or just after the inspectors identified themselves.

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Excellent powers of deduction

The bottom line was that none of the details really mattered (and the tax inspectors must have thanked their lucky stars for that). Once the judge had cleverly concluded that there was no way the officials could have been in the shop confronting Mr Butcher within anything close to 2 minutes – the mere fact that he was late in ringing up the purchase was enough to sink him.

Israeli bookkeeping regulations, based on statute and relying on case law, require any amount received to be registered ‘close to undertaking the transaction’. Motive is not relevant – the regulation is not designed just for tax evaders; it is also designed to prevent people honestly forgetting. So, ‘close to undertaking the transaction’ broadly means ‘immediately’ ie ‘right now’. (On the other hand, had Mr Butcher been able to show that it was a genuine mistake – wink, wink –  he would have probably been given a second chance, on condition nothing went wrong within the next 12 months.)

In the event, Mr Butcher’s accounting records were declared unfit for that year and, presumably,  the previous one. To be clear, that is a smelly state of affairs – the tax authorities can assume higher income than reported, and fines may be imposed.

While the non-registering of income is the most critical offense, there are a myriad bookkeeping rules for differing areas of business, right down to the specific layout of tax invoices. If practice is materially out of sync with the regulations, the same result can occur as with Mr Butcher. (Even the ‘second chance’ is scary as a sneaky follow-up audit could be expected during the probation period).

The takeaway should be that, anybody running even a one-man business needs to be sure that all details of the complex bookkeeping regulations are adhered to. That will, more often than not,  mean using the services of a professional bookkeeper.

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Hull – the UK’s current City of Culture

The first corporate liquidation in which I was involved, some 35 years ago, was of a Hull (a coastal town in Northern England) based fishery. They sent the records down to London. When we opened the boxes, the books stank in more ways than one.

Que?

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The British University of Glue

The English language often lags scientific progress. We still ‘turn on the radio’, even if none of us have seen a dial in years. When my kids were growing up, I always reminded them to ‘pull the chain’ even though toilet flush mechanisms had long been more user-friendly. And today, our computers offer us the opportunity to ‘cut and paste’ when there isn’t a pair of scissors or tube of glue in sight.

Early in my career, cutting and pasting was the standard way a kidnapper combined letters taken from a newspaper into a ransom demand, and a tax adviser pulled the disjointed components of a document together into a work of art that could demand a ransom. As we went (the ‘we’ being tax advisers rather than kidnappers), we deleted and replaced inconsistencies of language with red biro, and sent the resultant scrolls down to the soon-to-be-cursing typists.

Well, thanks to Word, those days are long numbered – but something close is going to hit the tax world like a tsunami next year (in fact it has already hit – but in very limited circumstances).

The Multilateral Instrument (MLI) – that won wide praise for the fact that it happened at all – is going  to make a lot of people’s lives (including mine) a misery, and no amount of Microsoft wizardry is going to lift  spirits; the Gettysburg Address was a magnificent eulogy – but it didn’t help the poor fellows buried there.

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Lost. Full-stop (Google translate: Period)

For the uninitiated, the MLI is a 49 page document of semi-comprehensible English and French that modifies bilateral tax treaties without the need for excruciating bilateral negotiations. Over a hundred countries signed up to the basic wording (the latest entries into force, in the last fortnight, are Malta and Singapore), with multiple choice opportunities for certain clauses, the right to exclude other clauses or sub-clauses that are satisfactorily covered in a specific bilateral treaty, and the right to ignore yet other clauses. There is also a right not to include another country (Israel has, for example, so far excluded the UK, and only the UK). The document deals – as part of the BEPS project – with hybrid situations, treaty abuse, avoidance of permanent establishment status, dispute resolution and arbitration. If you want a feel of how complicated it is – the section entitled ‘Simplified Limitation of Benefits’ runs to four and a half pages.

But that is not the difficult bit. If, for example, an Israeli adviser is going to consider a transaction with one of Israel’s 54 treaty partners that are not the UK, after establishing whether and when  that partner has signed up to the MLI, it is necessary to shoe-horn the relevant sections into the bilateral treaty, update specific sub-clauses, and then try and make sense of the different language styles and terminology without the benefit of a red pen – each change depending on the options the other side has chosen along the way. Cutting and pasting gone mad.

311fe468b42dace6de2e60adefc53918The OECD is making efforts to make it all easier with an MLI Matching Database (Beta) which,  at least, should obviate the need to view both country’s details with a split screen. Mind you, the OECD’s I-know-nothing disclaimer means it will also all need to be checked manually anyway. And, in any event, the cutting and pasting as well as different language are still there.

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Poor chap

The only long-term answer will be for some enterprising professional (probably a legal and tax publisher) in each country to produce updated treaties that read in one go from beginning to end.

I suppose we should be grateful that, with the United States not on board and the UK leaving Europe, they didn’t just do the whole damn thing in French.

Bog standard (almost)

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These days a bloke would do anything for a free ticket to Australia

Charles Dickens’s fecund imagination allowed Pip’s benefactor Magwitch to return to England  from transportation to an Australian penal colony, albeit at risk of judicial execution. By all accounts, thanks to the triple-knot of location, location, location, escape for  real-life transportees wasn’t all that simple. What the desperate convicts of the nineteenth century needed was the solution of the  twentieth – air travel. And, in a twist of fate, the first person to pilot a controlled flight in Australia (back in 1910) was none other than history’s greatest master of escape, Harry Houdini.

Well, by now, the world’s tax advisors are becoming used to the locks, double locks and padlocks being used to prevent international tax planners from thinking out of the box. But, the tax treaty signed (though not yet ratified) last month between Israel and Australia plonked a kangaroo, with a 10 ton weight in its pouch, on the box’s lid.

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Truth be told, the Wright Flyer never did move very much.

The treaty itself is not very exciting. It contains much of the usual – just about comprehensible – gobbledygook, together with a fair share of the totally ludicrous. An  example of the latter: SHIPS AND AIRCRAFT SHALL NOT BE REGARDED AS IMMOVEABLE PROPERTY. Thanks for that.

There is also an unhealthy obsession with the amount of time that needs to elapse before work on a  construction site or installation project by a resident of one country  becomes taxable in the other – too many numbers and too many conditions (and given the nature of trade between the two countries – not too many instances).

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Spreading the love (and hate)

At the end of the day – as with all treaties – it is withholding taxes that are the real bread, butter and Vegemite of the agreement. These fit within the ‘new normal’ of international double taxation treaties: 5% – 15% for dividends, 5% – 10% for interest, and 5% for royalties. It is the Australians who benefit from this much more than the Israelis. While, in the absence of a treaty, dividends from Israel can rack up upwards of 30% tax, as long as Australian corporate income is franked (ie the company paid tax in Australia), there is no Australian withholding tax. Similarly, Australia’s withholding tax on interest is 10% as opposed to Israel’s mainly 25%. Only when it comes to royalties are the tables  turned.

Among the sparse points of genuine interest is the question of whether the exemption on pensions from Australia to Israel applies to immigrants to Israel in their first 10 years of residence.That one will have the experts opining vigorously.

What makes this treaty ‘different’ is the (what I believe to be unique) ‘Article 28, Protocol’. Now, many treaties have protocols which are agreed explanations and adjustments to those carefully negotiated agreements.  The recent protocol (not yet in force) to Israel’s treaty with the UK (Tax Break  27/1/19) is effectively a new treaty. But, to have a section in the treaty that simply refers to an attached protocol as part of the treaty is – at first sight – circular and balmy.

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No!! Not Hybrid Instruments!

However, closer inspection reveals all. Article 28 is to tax advisors what Room 101 was to Winston Smith in Orwell’s 1984 – the fulfillment of their greatest fear. Among all the normal explanations and clarifications, just in case anyone had any ideas about favourable interpretation of the treaty,  is a section that lists most of the goodies of the BEPS project, stating that nothing in the treaty can stop a country clobbering anybody who tries it on, whatever the wording. Game, set and match.

The Great Houdini’s most famous escape was from a water-filled tank in which he was inserted upside down, heavily manacled. Antipodean tax planners will  soon be standing upside down working out what to do next, together with their right-way-up Israeli counterparts.

Tell it like it is

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Not a robot? Spot the quotes

A rose by any other name would smell as sweet’. That quote from Romeo and Juliet has occupied my thoughts this last week. As an Israeli judge found recently, the concept is only a ‘truth universally acknowledged’ to the extent the rose is inarguably a rose. And, in the process, the learned gentleman took pains and, dare I say liberties with the law, to rub compost in the face of the Knesset (Israel’s parliament).

Israel has had a Law for the Encouragement of Capital Investment for the last 60 years. Primarily a treasure chest of tax and monetary incentives to further the needs of the economy, it has been touched up and renovated periodically as the needs of the State changed and matured. In 2005, in an attempt to simplify a cumbersome process befitting a formerly socialist country,  a boost was given to those industrial enterprises that exported a pre-ordained percentage of their production.

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Not a robot? You don’t need the word ‘export’ to understand ‘export’.

However, the word ‘export’ had to be expunged from the Law’s lexicon. Offering export incentives threatened a shower of fire and brimstone from the World Trade Organization and, specifically, those with whom Israel had free trade agreements (including the US and EU). So, the sophists engaged to draft the law came up with a need to meet one of the following requirements:

  • Income from a specific market must not be more than 75% of total income;
  • 25% or more of total income must be  from a specific market numbering at least 12 million residents.

That would avoid detection in a word search by nosy foreign governments,  while anyone with a brain that worked in accordance with evolutionary theory could interpret the law as demanding  at least 25% export, with no restrictions on the level of exports to any major foreign country. Why 12 million? Probably because it was a lot more than the population of Israel in 2005 (the number was updated a few years back to 14 million with an annual automatic increase).

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How can we be sure anymore that the number of residents of New Zealand doesn’t include the sheep?

Well, populations have a habit of growing, and by sometime in 2012  Israel’s market, which included the residents of  Judea and Samaria aka the West Bank had grown to more than 12 million, and companies that sold exclusively to Israel decided to claim the benefits of the Law. The tax authorities told them, in no uncertain terms, to go fly a kite.

The courts got involved and agreed with the tax authorities (the tax authorities’ argument had layers not elucidated here). The appeal was heard this month.

Although, at bottom line, the appeal was thrown out, the judge disagreed with the tax authorities that Israel could not, in principle, be included in the second condition, offering a long and reasoned argument. The upshot would be that no exports were required at all – a surprising conclusion. Interestingly, in addition to arguing that exporting was not the clear intention of the law, he completely ignored the first (alternative) condition which, although not negating entirely the Israel-only possibility, made the whole thing Monty Pythonesque.

Benjamin Netanyahu, David Bitan, Oren Hazan

They are going to take the judge’s comments very seriously.

Faith in the judge was restored, however, towards the end of the 39 page judgement. Quoting from some of the committee discussions surrounding the 2005 amendment, he lambasted the parliamentarians for the underhand way in which they had sought to hide the export incentive from Israel’s trading partners, making clear that white man mustn’t speak with forked tongue. If, as a result, they got their wording in a twist, they deserved to be punished. He forcefully suggested that the legislature should update the wording of the law.

There is nothing new, or unique to Israel, about actively confusing laws. Back in the 1850s, the author of Little Dorrit invented a whole government department to promote the idea – the Office of Circumlocution. But, perhaps, times they are a changin.

Dead Wrong

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April fool!

It’s bad enough that, thanks to the controversy surrounding Brexit, the average Briton no longer lives with peace of mind. From April 1 they will no longer die with peace of mind.

A headline-grabbing exaggeration perhaps, but probate fees for opening a file to deal with a deceased person’s estate are due to jump from £155 to, in some cases, £6000 from next week. While the government insists it is a fee – in order to avoid a legal requirement to include it in the annual Finance Act – the Office for Budget Responsibility announced on March 15 that it would be included, alongside Inheritance Tax, as a tax for statistical purposes.

Her Majesty’s Revenue and Customs  has been administering the controversial – and widely hated – Inheritance Tax since its inception in 1986.

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The Twilight Zone?

As in other countries imposing an Estate Tax or Inheritance Tax (there are many that have either cancelled or never adopted either) UK Inheritance Tax is  controversial for the wrong reasons. It is argued that it represents a double tax on already-taxed income, while at the same time not bringing in much revenue (other than from the good dead people of Guildford, the recently crowned inheritance tax capital of Britain). The first argument cries out for a different spin, and the second (it represents around 1% of tax-take) may anyway cease to be valid in the years ahead.

As taxes go, an Inheritance Tax makes a lot more sense than an Estate Tax.

An Estate Tax imposes tax on the estate of a dead person – beneficiaries receive what is due to them out of the post-tax value of the estate. There is, unquestionably, an element of double tax (although the likes of Thomas Jefferson and liberal philosopher John Stuart Mill gave the finger to that), and the fact that estate tax planning is entirely within the bailiwick of the donor (subsequently the ‘dead person’) such tax can often be minimized.

An Inheritance Tax imposes tax on the beneficiaries. In that case, the double tax argument is weakened – the dead person passes on their estate free of tax (but without a tax deduction for the transfer as they, rather than society, decide who is to receive it) and the beneficiaries – similar to the winner of a lottery – pay taxes on their windfall. As regards the level of collections, imposing tax on the beneficiaries also puts something of a spanner in the works of aggressive tax planning during the donor’s lifetime.

There are two types of inheritance tax  – accessions and inclusion. An accessions tax system provides the beneficiary with their lifetime tax-free inheritance threshold, and hits them with the prescribed rate of inheritance tax on  the balance of what they receive from any number of donors, while an inclusion tax  charges beneficiaries according to their marginal income tax rates  (plus an inheritance surcharge). While inheritance tax is always fairer than estate tax, the inclusion tax system is the fairest of them all – as it clearly works in favour of beneficiaries of smaller amounts and/or lower income.

Furthermore, in all cases (Estate Tax and both types of Inheritance Tax), the increased exchange of information between tax authorities mean it is increasingly difficult to hide assets ‘abroad’ – which should also substantially serve to increase the revenue collection.

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‘More tea, guv?’

Britain claims to have an Inheritance Tax. The problem is that – to all intents and purposes – no, it doesn’t. It has an Estate Tax. The government website (Gov.UK sounds like an initiative of the Kray Twins) talks to the donor. Other than in specific circumstances the tax is claimed from the estate. The tax-free threshold is given to the estate – and even in the case where specific gifts are given outside the will in the 7 years prior to death, they get first benefit of the tax-free amount. And the tax rate is fixed.

So, why is it called an Inheritance Tax?  We shouldn’t complain. At least it is called a ‘tax’ as opposed to the Probate Fee, which is a tax but the government can’t afford to call it that. And what about Her Majesty’s Revenue and Customs?  Isn’t it a tax authority?

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At least they still call it a ‘tax’ return

Perhaps we shouldn’t ask too many difficult questions of a country with a tax year-end of April 5th.

Ain’t no Bonanza

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Let’s face it. The bar was pretty low

Jay Leno once went walkabout in New York asking innocent passers-by if they could name a country beginning with the letter ‘U’. Apart from the usual camera induced deer-in-the-headlights non-responses, a few bright sparks came up with Uganda and Uruguay. At the close of the piece, as the camera faded out, Leno was heard asking: ‘Have you ever heard of the United States of America?’

Judging by the above experience, it can safely be assumed that, had Leno carried on to ask  the name of the alphabetically last of the 50 States, at least one person – having realized there was no State starting with Z – would have thought long and hard about Y and come up with Utah. Alternatively, still on Y, they might have gone for Wyoming. And Wyoming, dear readers,  is actually the correct answer.

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Named ‘The Virginian’, filmed in California, and set in Wyoming. Only in America

Although there is a tendency to think of Wyoming as still set in the 19th century, with characters like Buffalo Bill, Wild Bill Hickock, Doc Holliday and Calamity Jane ambling around the state capital, Cheyenne, it was the birthplace – in 1977 – of one of the most important tax sanitizers in US history.

The Limited Liability Company (LLC) – a mongrel of the corporation and partnership with descriptive terminology all of its own – crawled along at cowboy pace until 1988 when the Internal Revenue Service issued a ruling that LLCs were transparent for tax purposes. At the speed of a Colt 45, American taxpayers could suddenly combine the limited liability of a corporation with the personal taxation of a partnership or sole trader. This was particularly important in America where, despite Reagan’s major tax reform two years earlier, there was no correlation between the tax paid by an individual (up to 28%), and that paid by a corporation (up to 34%) followed by 28% individual tax on a subsequent dividend (over 52% in total). Congress failed to recognize that inanimate companies – while being vehicles of tax liability – cannot pay tax. Unlike Shylock, if you prick them, they do not bleed. Human beings pay the tax – either through the higher prices suffered by the consumers, or the lower profits earned by the shareholders. There is little justification economically for wide differences in total rates.

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Companies don’t have anything to cuff, either

As it turned out, it took until 2018 for the tax rates to be aligned. In the meantime, the vast majority of American private businesses organized themselves as either sole-proprietorships (and partnerships) or – thanks to Wyoming’s pioneering spirit – the new fangled LLCs.

And, thereby, hangs a tale. It was all well and good that America – with the biggest economy in the world – knew how to treat her LLCs, but other countries struggled with defining their treatment under their own laws. They ended up one of the major ‘culprits’ in hybrid mismatch tax planning that was so fiercely attacked in the OECD’s BEPS initiative.

 

Put simply, tax transparent companies in Israel are a rare and specific phenomenon. On the principle that, if it walks like a duck and talks like a duck, it’s a duck, LLCs fit the bill as companies. Therefore, according to statute law, they are not transparent.  However, given the large exposure of Israelis to the American economy, ever since its big 2003 tax reform the Israeli Tax Authority has been finding accommodation for these hybrid beasts. As long ago as 2004 it produced a circular that reiterated the corporate nature of the LLC, but offered solutions to the availability of a foreign tax credit for US individual tax being paid (since the LLC is tax transparent in the US). If the LLC is deemed controlled and managed from Israel, despite being liable to Israeli corporate tax, a credit is given for the US individual tax on profits attributed to the US (up to the level of the corporate tax). Alternatively, the taxpayer can elect at first filing to be taxed on the profits in Israel at the member (Google translate: shareholder) level, with credit for the US taxes. Some have incorrectly interpreted that as complete transparency for the LLC. In fact the circular stresses that the LLC is a body of persons and, in practical terms, that means that losses of  one LLC cannot be offset against those of another. As LLCs are set up at the drop of a cowboy hat in the US, this represents a real problem for many Israeli investors. There are certain planning devices, but advisors have always been aware that the problem exists.

Remarkably, 15 years after the issuing of that circular, essentially an extra-statutory concession, some  jester with nothing  better to do recently inexplicably allowed – not for the first time – a no-hope case to be brought before the courts. The claimant had set off losses between LLCs – in defiance of the circular – basing his claim on (1) Israeli law determining that when a word is stated in the singular, it also means the plural, unless – inter alia – the context does not support that interpretation, and (2) an informal conversation with a senior tax officer who allegedly told him that the problem could have been solved if all the LLCs had been held under a single holding LLC.

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Why have they stopped us handing out the death penalty?

The judge swatted away the first argument – the context clearly didn’t support the multiple LLC claim. But, the second argument was even more off the wall. Whether or not the senior tax officer had been quoted correctly about forming a group of LLCs, THE CLAIMANT HAD NOT DONE SO. Robert Frost wrote a famous poem on the subject, ‘The Road Not Taken’

‘I shall be telling this with a sigh
Somewhere ages and ages hence:
Two roads diverged in a wood, and I—
I took the one less traveled by,
And that has made all the difference.’
His Honour politely demolished this argument, too. Had I been the judge, I would have been tempted to return to the cowboy country roots of the LLC and quote from Clint Eastwood’s 1976 Western, ‘The Outlaw Josey Wales’:
‘Don’t p**s down my back and tell me it’s raining.’

Prospecting for tax

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True heroes…

If you hear the term: ‘sans frontieres’, it is odds on that – after ‘French’ – the first thing that will come into your mind is ‘Medicins Sans Frontieres’, that truly remarkable international humanitarian medical NGO founded in 1971 and based in Switzerland. Add to that ‘Avocats Sans Frontieres’, the human rights lawyers, and a plethora other ‘Without Borders’ organizations, and your forehead will probably furrow as your thoughts turn to the altruism of Churchill’s ‘Never in the history of human conflict was so much owed by so many to so few’, and Kennedy’s ‘Ask not what your country can do for you’.

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… and true fools

As proof of my innate cynicism, when for the first time last week I came across  ‘Inspecteurs des Impots Sans Frontieres’ (Google translate: Tax Inspectors Without Borders), my agile memory leapfrogged all those worthy international bodies dating back to the early seventies. ‘Jeux Sans Frontieres’ – known on my TV set as ‘It’s a Knockout’ – was a banal  pan-European TV competition tracing its history to 1965. Similar to a well-funded kids’ birthday party, participants were required to engage in physical contests of the utmost idiocy. Europe had been laid waste twice in the preceding half century by the two most utterly mind-boggling catastrophes in the annals of mankind, and this was the reward.

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Tax inspector in the mind’s eye

Thinking my memory was treating the world’s tax inspectors to the respect only they deserved, I plunged first into an Economist article – the headline of which had introduced me to TIWB – and then the  OECD literature on the topic.

I was wrong.

TIWB was founded by the OECD and UN in 2015 around the time the world’s governments started to take international taxation cooperation seriously. Tax administrations with well-developed international tax audit capabilities, as well as retired tax inspectors, are now targeted to assist less fortunate administrations with developing their own tax audit capabilities.

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It just got harder

It turns out there are dozens of these projects going on around the world (there is even a bi-annual newsletter), and it is estimated that, for every dollar spent, a hundred dollars of tax avoiding revenue is collected.

Along with complex changes in rules, much of the stress over the last half-decade has been on transparency and the exchange of information. But, if a cash-strapped tax administration does not know what to do with all the data it receives on international groups  who exploit the system to the full – albeit within legal limits – little will happen. Projects based in the Caribbean, Africa, Asia, Latin America and Eastern Europe are closing the gap. According to the IMF, over 20% of tax revenues were still being lost to the legal playing of the system as recently as 2016.

It looks like it is time to take tax inspectors seriously. When American humorist Dave Barry was chosen for audit in an  IRS sample, he wrote a syndicated article of comical unctuousity to the Service: ‘The truth is that I have the deepest respect for the IRS, and for the thousands of fine men and women and Doberman pinschers who work there….IRS are regular people just like you, except that they can destroy your life.’

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I do, honestly

I have decided to  turn over a new leaf and show respect to tax inspectors whether with or without borders. They are good people. Really good people. Really.

Monkey business

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Pass the monkey wrench

In its relentless efforts to clean us all up, the Israeli Tax Authority has just thrown another spanner in the works of the well-greased black market.

Meek householders faced by odd-job men  demanding cash as they flex their bulging muscles, not to mention seasoned mafiosi and disgraced politicians, will be questioning my timing. Surely,  the ‘Law for Restricting the Use of Cash’ was last year’s news, albeit that it only came into effect two months ago? The man with the leaky roof has already hardwired his brain with a little red light that goes off  when he hears – in a plethora of accents and grammatical constructs – the sum of eleven thousand shekels. Although that is not the final word (or number) on the maximum amount that can be paid in cash – it is a good trigger for the sweat glands to open. From October this year, not only those that demand cash, but those who pay it, will be liable to a fine if caught.

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Cheques are so much easier

The reason for mentioning the incursion into the colourful world of banknotes now in particular is the helpful simulator the tax authority has recently uploaded to its website. The idea – it appears – is that Joe Public can check, in the space of less than a minute, whether a cash payment he plans to receive or make is permitted and, if not, the ‘damage’ if he is nabbed by the long arm of the law.

Having carefully read the authority’s professional circular, replete with numerical examples, and then tested the simulator with the same examples, I have – at time of writing – two criticisms. Firstly,  the simulator’s results in respect of penalties are wrong – someone forgot to program the simulator’s programmer with the correct terms of the law. But, what is a little boo-boo among friends? It is the second point that, in my humble opinion, is the real issue, and on which I feel compelled to dwell.

For a deterrent to be effective, those it targets must either live in abject dread of the terrible consequences of breaking the law: death by hanging, prolonged incarceration, financial ruin; OR they must be left to fear the unknown.

The moment taxpayers can punch the numbers into their smartphones and summon up the bad news – which, starting at 15% of the illegally paid amount, is an irritant rather than a life-destroying event – for many the fine simply becomes a refinement of the black market calculation.

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Joe Public

An example will help the explanation. The abovementioned Joe Public, a typically morally unchallenged householder, hires Art Dodger to redecorate  his house. Art gives Joe a price, but tells him that – if he pays 25% in cash, he will knock off the VAT.  Until the recent change, the only thing stopping Joe was his civic responsibility which – given that he is typically morally unchallenged – is probably handsomely outpriced by the discount. Art, on the other hand, has had to make a risk assessment before making his offer. He will not be declaring VAT and income tax. He probably reckons that – even if he is found out – he will get away with a slap on the wrist and paying both taxes with interest. All in all, the income tax saving is appealing.

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Art Dodger

Enter the new law, and the soon-to-be-corrected simulator. Art retains his sunny outlook about not getting caught. Joe, on the other hand, now knows he has a risk – and, thanks to the simulator, knows exactly how much as he sits across from Art at his kitchen table. Joe might – as the law (and its simulator) hopes – tell Art to forget it. On the other hand, he might – depending on the amount at risk – ask Art to improve his offer. If that happens – depending on how Art responds – the black market  just got more sophisticated.

If I were the tax authority, I would bury the penalty part of the simulator, defects and all, in a very deep hole. The black market is a scourge that, deep down and however much our moral compass waivers , we all want to be rid of. The new law is a step in the right direction.

Oh, and they could always reassign that programmer to ‘Tax Refunds’.

Nexus, shmexus

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What tax advisers think they look like

In my halcyon days as a tax adviser, a client conference meant lots of numbers thrown at a stark white screen via an overhead projector, the small audience looking pale and bored under the harsh fluorescent lighting. We, the professionals, were geeks that nobody wanted to talk to unless we were saving their cash, or saving their hides.

It transpires that  a quarter of a century is a long time in tax, and in recent years we have found ourselves in  conference centers bathed in blue light, no numbers in sight, talking (and talking) about ‘paradoxes’ and ‘paradigm shifts’, and other intelligent concepts that have as much to do with tax as that other famous three-letter word ending in ‘x’. It isn’t that much has really changed. It is just that we have learned to talk-the-talk and walk-the-walk in our designer suits. The meaning of the words – or their dubious relevance – doesn’t really matter. Conferences are all about the sound bytes and the press coverage. The public face of tax has had a makeover.  Meanwhile, real tax consulting – exactly as in the good old days – continues to be undertaken by consenting adults behind closed doors.

It is, therefore, with some trepidation and a shaking pen, that I find myself writing about – what might actually be – both a ‘paradox’ and ‘paradigm shift’  in international taxation.

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When physical nexus made sense

I refer, of course, to the OECD’s invitation for public input on the possible solutions to the tax challenges of digitization. The topic is not new (see Tax Break October 5th 2018), and is, indeed, Action 1 (of 15)  of the Base Earnings and Profit Shifting (BEPS) initiative that has been monopolizing the attention of tax practitioners for the last five years. However, it has for some time been looking like it would be sacrificed on the altar of disagreement and procrastination, as it requires a complete rethink of two of the pillars of the existing century-old system – nexus (connection to a country) and profit allocation (between countries).

On February 13th, the Inclusive Framework on BEPS (comprised of just about every self-respecting nation in the world – not to mention a few others) came up with a Public Consultation Document, the member countries having previously been divided on any way of moving forward. To be clear, it is stressed that the comments are ‘without prejudice’ (which I think means countries are not committed). Different countries have different interests – in the rawest of terms developing countries that are not hi-tech originators have a major interest in attracting tax from digital companies interacting with their populations, while the United States would ideally like to keep as much of Google and friends’ taxable income as possible for itself. The indisputable paradox here is that – in a world veering more and more towards trade wars and protectionism –  they  were able to come up with a series of alternative proposals, any one of which  – if adopted – will represent a paradigm shift in international taxation affecting everybody.

There are three proposals for tampering with profit allocation and nexus, with the aim of ensuring that taxable profit is allocated according to where value is created.

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No comment

The first proposal focuses on ‘user participation’. This is fairly specific to the ‘highly’ digitalized economy –  social networks, search engines and on-line marketplaces, where the activities and participation of these users contribute to the creation of the brand, the generation of valuable data, and the development of a critical mass of users, which helps to establish market power. For this purpose, nexus would no longer be only to where the company physically undertakes its business. but also to  where the users build part of its profits, with suitable allocation of those profits.

The second proposal is based on ‘marketing intangibles’ such as brand and trade name which are reflected in  favourable attitudes in the minds of customers and so can be seen to have been created in the market jurisdiction. There are also other marketing intangibles, such as customer data, customer relationships and customer lists  derived from activities targeted at customers and users in the market jurisdiction, supporting the treatment of such intangibles as being created in the market jurisdiction. Once again the definition of nexus would need to be expanded beyond the physical and profit allocated accordingly.

The third proposal relates to ‘substantial economic presence’ via digital technology and other automated means. Such presence could be evidenced by:  the existence of a user base and the associated data input;  the volume of digital content derived from the jurisdiction;  billing and collection in local currency or with a local form of payment;  the maintenance of a website in a local language;  responsibility for the final delivery of goods to customers or the provision by the enterprise of other support services such as after-sales service or repairs and maintenance; or  sustained marketing and sales
promotion activities, either online or otherwise, to attract customers. Same again, in terms of revolutionary forces in international tax.

As already mentioned, each of the proposed methods requires an overhauling of ‘nexus’, until now based on a level of  physical presence in a jurisdiction, and ‘profit allocation’ which – even in the BEPS world – suffers from the vagaries of the Old World Order.

Pending public comment – the deadline for which has been extended to March 6 – the bets are on  ‘Marketing Intangibles’ over ‘User Participation’, the former catching a wider cross-section of the digital industry in its net. ‘Substantial Economic Presence’ was a late arrival at the ball, and  – if the digital tax revolution is consummated – will likely be confined to the role of chaperone.

Will anything happen? There is no question that the BEPS project has achieved a momentum that could not have been predicted five years ago. The Americans are said to favour ‘marketing intangibles’ – although when they calm down from the sound bytes, soft blue light and dark suits, they might start to run the boring numbers and discover it (and any other change) is not in their best interests.

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‘I am just the greatest ever paradox and paradigm shift!’

So, it looks like ultimate success in achieving the paradigm shift rests on the continued goodwill of the United States, which in the current political climate would be a paradox par excellence. But, we are living in interesting times.

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