Tax Break

John Fisher, international tax consultant

Archive for the tag “humor”

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

Cholera vaccination at Nyaragusu refugee camp in Tanzania

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.

Embrace the Model Treaty

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A real heavyweight of the small screen

When wheelchair bound ‘Ironside’ star Raymond Burr walked confidently down the aircraft steps at Lod Airport in 1974, the reaction of the Israeli public was something akin to the second coming. Still caught in the long shadow of the Yom Kippur War, Israelis were far closer to Tom Brokaw’s ‘Greatest Generation’ than  consumerist 1970s Western Society.  But, that didn’t stop them going bananas over an American TV personality.

Nearly half a century later, Israelis have taken their dubious place in western culture, and they can now fawn and slobber over their own lesser stars. Bar Refaeli – whose completely unearned claim to fame emanates from a combination of heaven-endowed gifts and an unearthly attachment to  silicone – has the nation goggle-eyed over her tax affairs. Based on tabloid rumors, she appears to be in a civil disagreement with the Income Tax Authority over whether she was justified in claiming not to be resident in either Israel or the United States while she shacked up with an Italian-American actor, and in a criminal disagreement over whether she – and her parents – hid critical facts from that same, august authority.

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Tax inspectors are only human after all

More worryingly, the tax authorities themselves seem to have jumped on the media bandwagon with the announcement last week that a committee has been set up to review the criteria for tax residence with a view to establishing greater certainty. Oh dear.

Starting with  the last major tax reform in 2003, Israel has moved forward steadily with the removal of ambiguity about Israel tax residency in domestic law. There was a useful addition to the law in 2007, a requirement to report the basis for an aggressive non-residence position from 2016, and several landmark court cases in recent years. Furthermore, Israel now has double taxation treaties with substantially all the countries Israelis are likely to clear off to (Australia is taking up the rear), which take precedence over domestic law where there is a dispute.

What appears to have put up the Tax Authority’s blood pressure in the Refaeli case (and, in fairness, those of a few other mega-rich individuals) is the claim not to be resident anywhere. That was ably dealt with in a court case back in 2016 concerning a poker player, when the judge made clear that such cases would be rare in the extreme (he even quoted the classic case of a person living on a yacht in the middle of the ocean).

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Sometimes it needs more than the instructions

The problem, if there is one, does not arise  from Israel’s lack of certainty in defining residence. In fact, Israel – in broadly paralleling the OECD Model Treaty guidelines – has a very healthy approach, combining qualitative tests (a person’s center of life), and secondary quantitive tests (number of days present). The problem is that the United States, going it alone as always, relies – at the first level – on a purely quantitative approach. So, in theory at least, an individual like Ms Refaeli could make sure they did not hit the quantitative test in either country, while claiming ‘center of life’ in the United States, where they don’t really care. Hey presto! Not resident anywhere. Any effort to achieve more certainty – like in the United States pure quantitive approach – is probably doomed to abject failure.

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His judgment is not to be trusted…

In cases like Ms Refaeli’s, it is surely far safer to have an Israeli judge look qualitatively at the situation in the light of the facts, and then – as Her Ladyship dons her black cap – stare the  defendant coolly in the eye while pronouncing sentence.

 

 

GILTI until proven simple

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What a joke

Appearing on Johnny Carson’s Tonight show in 1975, the ex-governor of California quipped: ‘We live in the only country in the world where it takes more brains to figure out your income tax than it does to earn the income.’ A little over a decade later, the same gentleman put his pen where his mouth was, and signed into law the Tax Reform Act of 1986, ostensibly simplifying the US Tax Code.

Well, I have to admit that I didn’t take much interest in the Code before Reagan’s reform, but – if that was simplification – I dread to think what it was like in the good old days. Fast forward thirty-odd years and Donald Trump was playing the same game. Or was he?

As US taxpayers start to consider their first  filings under the latest reform, one example should show just how complex the damned thing is.

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He also borrowed the line

As of  2018 the US corporate tax system went over to a territorial basis. That broadly meant that dividends received from abroad by US corporations would be exempt from tax. Nothing is ever that simple. America had invented, back in 1962, the concept of Controlled Foreign Corporation  (today the internationally ubiquitous CFC) which essentially taxed passive and certain other profits parked in tax-advantaged jurisdictions on a current basis, irrespective of whether the income was repatriated. But, if they were to transition to a territorial basis, that wasn’t enough. To paraphrase Mr Carson: ‘Wheeeeeere’s Google/Amazon/Apple?’ What about active income being cleverly sheltered in the Islands and Irelands of the world? And so was born Global Intangible Low Taxed Income (GILTI). After certain adjustments, foreign income (‘intangible’ was evidently thrown in to make a good acronym) would be taxed at half the federal tax rate (10.5% in the New World Order) with a foreign tax credit for 80% of the foreign tax paid on the income. That meant that a foreign tax rate of over 13.125% cancelled out the US tax (which is the same effective rate on Foreign Derived Intangible Income – the export incentive offered to US corporations under the reform – meaning there is ostensibly no tax advantage to going through loops to carry on the business offshore).

So far – if a little complicated –  bearable. The fun starts, however, when considering the effect of GILTI on individual or transparent entities (LLCs, S Corps, Partnerships) investing directly in foreign companies. Once caught within the CFC rules, their position becomes untenable. As it seems right now, they get no 50% deduction for GILTI and no foreign tax credit. That means they have to pay up to 37% tax on the gross income abroad, in addition to the local tax paid.  Given that the foreign jurisdiction may impose withholding tax on distribution of an actual dividend (albeit that such tax may be credited – if there is other income – in a general basket separate from GILTI), and given the exposure to State taxes and Obamacare, it is time to consider buying a one-way ticket  up the Empire State Building.

Now, straight-thinking people  might have thought this was a mistake, calling for suitable regulations to correct the situation. Evidently not. In this (once again) newly simplified world of US tax the solution being screamed from the rooftops is for the individuals to make a S962 election for their income to be treated as corporate  for tax purposes. That way they (probably) become eligible for the foreign tax credit – although the 50% deduction still looks doubtful. Because they have elected to be treated as a corporation, there is tax to pay on the ‘dividend’ when received. This ‘might’ be eligible as a qualified dividend (23.8% tax) and there ‘may’ be a credit to be had on the foreign withholding tax. But, nobody seems very sure.

This is simplification?

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Don’t try this at home, kids. It’s just for movie stars

I recall an interview with the conservative intellectual guru William F Buckley Jr. on the night of Reagan’s 1980 victory. Asked why he wholeheartedly supported the former actor, he told a story (much as the newly elected president might). He had been one of a group, including Reagan,  attending a meeting in a room on a high floor of a luxury hotel. The door became jammed, and they couldn’t get out. Reagan proceeded to climb out of the window, feel his way  along the perilous ledge to the next room, where the window happened to be open, climb in and come around to open the door from the outside. To the genuinely brilliant Buckley, that showed decisiveness, and made Reagan eligible to rule the world. When I heard this, my immediate reaction was: ‘Wouldn’t it have been simpler to just call reception?’

Perhaps the Americans just have a different concept of  ‘simple’? After all, as George Bernard Shaw is reputed to have said: ‘The English and Americans are two peoples divided by a common language’.

Telling it like it isn’t

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Very last call …

A rabbi, a priest and the secretary-general of the OECD walk into a bar… Not heard that one before? Read on.

Last Wednesday, January 2nd, as the 20th Knesset breathed its last before flatlining in the run-up to a General Election, the Finance Committee approved regulations paving the way for the introduction of the international ‘Standard for Automatic Exchange of Financial Account Information in Tax Matters’.

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Game over

The New World Order, where there is nowhere for the less-than-honest to hide their ill-gotten gains, has been heading this way to much fanfare for some time. Too long, in fact. Israel signed on to the G20/OECD 2014 initiative early on, and was committed to having the necessary legislation in place by January 1st 2017. This was to be followed by necessary bi- or multilateral agreements (it committed to two multilateral ones), necessary bilateral commitments to ensure  the other side would respect confidentiality – as well as being both legislatively and operationally sound – and technical guidance to Israel’s banks on how to provide data on accounts of foreign resident in standard international format (so they could be easily deciphered at the other end). Information exchange was to start in September 2018. In fairness, Israel didn’t score too badly other than on one rather critical point – although legislation was in place in mid-2016, well in time for the 2017 deadline, it could not come into force until accompanying regulations took effect.

Well, as the naysayers would have it, a miss is as good as a mile and the road to hell is paved with good intentions. By December 2018, there were only seven countries that were non-compliant: Antigua & Barbados, Brunei Darusallam, Dominica, Niue (is that a country or a spelling mistake?), Qatar, Sint Maarten and … Israel. This prompted a desperate letter from the secretary-general of the OECD to Israel’s prime minister, and the eleventh hour passing of the regulations last week, exactly two years and one day late. If you are going to be late, you might as well do it in style.

What went wrong?

The required regulations, as the American FATCA information exchange regulations before them, hacked at one of the mainstays of ultra-Orthodox society (and a much valued traditional Jewish institution)  – the ‘Gemach’. The concept is a simple one. Groups of largely anonymous donors provide money to an intermediary who generally disburses the funds as interest free loans to those in need. In the event the borrower is unable to repay, the donors (who have generally kissed goodbye to the money) have no recourse. Until now, these arrangements have had no legal or regulatory basis – essentially private arrangements that could run into incredibly large sums. When FATCA came along, Israel’s banks started closing Gemach accounts as they were unable to verify to the US authorities that there were no US ‘depositors’. On the other hand, as the chairman of the Finance Committee repeatedly protested, requiring a donor who gets nothing other than a place in Heaven out of the whole process to fill in forms for the tax authority is a kiss of death for the institutions.

A solution was found, with the evident acquiescence of the US authorities, for small Gemachim, and in August 2016 Gemachim generally were given two years grace, in which time they would – against their will – be brought under regulation, and they could organize their affairs to be compliant for the banks. To cut a long story short, after a lot of weeping and gnashing of teeth, including the flat refusal of the Bank of Israel and Capital Markets Authority to supervise them (The Capital Markets Authority lost, and ‘won’ the job), the very last piece of legislation to pass its third reading in the 20th Knesset was the attrition-much-reduced Gemachim Law, which paved the way for the Chairman of the Finance Committee to agree to approve the information exchange regulations.

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The only thing crooked about him

Had the script of this farce been written by the 2008 financial crash’s moral voice, then Archbishop of Canterbury Rowan Williams, the Finance Committee and Israel might have walked away with their heads held high. Williams had maintained that the ‘markets’ that bankers claimed dictated the path of the financial system, were – in Judeo-Christian – terms a form of idolatry, something man-made being attributed independent powers. He argued that modern financial transactions lacked the face-to-face component of yesteryear – it is much easier to default when lenders are obscured behind a curtain of intermediate transactions than when recognized at an individual or community level. Here were self-regulating funds that should not be collateral damage in the post-2008 meltdown regulatory war against the unfettered avarice of the players in the financial markets.

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There are always the traditional methods

However, Anglicanism hasn’t had much of a look-in around these parts since 1948, and  the ‘guilty’ Knesset Finance Committee was chaired until last week by an ultra-Orthodox rabbi-politician not given to philosophical musings, but rather to horse-trading in the name of his flock. The reason there was a need for a law regulating the Gemachim was that a number of them, predominantly in the United States and Israel,  had been the facilitators of big-time money laundering and tax evasion. A war of attrition in the long process of arriving at the final wording,  holding the inevitable (and, hence, unforgiveably late) information exchange regulations hostage,  is considered  to have severely compromised the regulatory effect of the law. Any collateral damage ultimately suffered by the moral majority of Gemachim is thanks, therefore, to the unsavoury dealings of some of their number, rather than the excesses of the financial system.

The last weak joke of the 20th Knesset…

Comfort and joy (for some)

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This Prime Minister doesn’t need a babysitter

Several years ago I wrote a newspaper article about a fresh addition to the Israeli Income Tax Ordinance that included four subparagraphs. Or, at least, there should have been four subparagraphs. The fact that there were only three made the whole thing toothless. My tongue-in-cheek piece suggested a scenario where the Knesset Finance Committee was working late into the night, and the person with the most tax knowledge received a phone call that they had to relieve the babysitter – so they all went home. Joke – right? The following day I received a call from a senior tax official asking me how I knew. You couldn’t make it up.

Monkey-typing

If you pay peanuts….

The drafting of tax legislation in this country is often notoriously slapdash. But, that doesn’t explain all the problems with tax statute. For a start, there is the pain of keeping up with changing business environments – just look at the mess the international tax system is in over taxation of the digital economy. And then there is accounting. Corporate taxation is based on accounting profits.  Once upon a time, thanks to the ancient simple art of double entry bookkeeping, the profit and loss account was a fairly close reflection of the dollars and cents performance of a company give or take capital expenditure, debts, liabilities, inventory, and the odd accrual . A few additions and deductions and the taxman could take his toll. An explosion of accounting standards plus that thing they call IFRS led, in recent years, to more adjustments to the accounting profit than fairy lights on a Christmas tree – but as long as tax departments kept their heads, it could be handled. Almost.

For reasons best known to the British Mandatory Authorities that planted the seeds of our tax law, dividends – while mentioned freely throughout the Ordinance – are not defined for tax purposes. The upshot is that they go according to company law and are ultimately calculated in line with the latest whim of the accounting wonks in their ivory towers. That means that a company can distribute either more or less than its taxed profits. It’s the ‘more’ that bothers us here – or more precisely the parties to a court appeal that was heard this month.

Israel adheres broadly to the classical system of taxation – corporate profits are taxed twice, first at the company level, and then in the hands of  the individual on dividend. In order to avoid taxation mushrooming to three, four or heaven knows how many times, if there are several layers of companies passing dividends up the chain, Israel generally exempts intercompany dividends on which Israeli corporation tax has been paid. The second level of tax waits for distribution to the individuals right at the top.

General view of Buckingham Palace in central London.

Rumour has it, her great-great-great-great grandfather bought this place for a fiver.

That last paragraph probably sounds logical to anyone reading this – but it demanded a 39 page, beautifully reasoned ruling by the judge to put it to bed. The appellant company had received accounting profits from a subsidiary manufactured from the revaluation of certain real estate on which tax had, correctly, not been paid as the real estate had not been sold. The tax authorities and a judge had already told the appellant that the intercompany exemption didn’t apply. The company decided to try its luck on an appeal using a combination of sophistry (the wording  – but not the intention – of the law was, indeed, pitiful), a real concern for future double taxation (the subsidiary would be liable to tax on sale of the real estate even though tax was being paid now by its parent), and a childlike plea that, if all else failed, could the nice judge please treat the whole thing as a nightmare and pretend the dividend didn’t happen.

The judge wasn’t having any of it. He countered their sophistry with his own, and treated the request to reverse the transaction like a parent  explaining to a 6 year old that Santa doesn’t really exist. That was all reasonable and fine – but, it was the double tax issue that restored my faith in a system that so often seems broken.

The judge analyzed the concept of avoiding double taxation in Israeli law. He noted that, while the double taxation issue is an important principle underpinning the law, there are situations where double tax applies – predominantly where there is a change of ownership in-between certain transactions. Had the appellant sold the shares to a third party, its representatives would not have been in court arguing that – because the subsidiary company would have to pay tax again in the future on sale of the real estate (the value of the shares sold now would already have taken into account the increased value once), it should be relieved from the resulting double tax.

The Ten Commandments. Image shot 1956. Exact date unknown.

Thou Shalt Not Steal

So, armed with that logic, the judge rejected the appeal and insisted that tax was payable on receipt of the dividend. However, he literally ‘commanded’ the tax authorities to relieve any subsequent sale of the property from double tax, as long as there was no change of ownership in the meantime. That produced a result in parallel with normative Israeli law, as opposed to a narrow, literal interpretation that could have caused unnecessary hardship.

All too often, tax rulings rely on logic as much as  a fish relies on a bicycle. Not this time.

A Merry Christmas and Happy New Year to all those celebrating.

Wakey-wakey!

clock

Two minutes to midnight

It is the morning of the Maths exam that will decide which, if any, university awaits the candidate. He/she suddenly realizes that he/she hasn’t even started learning the syllabus.

How many of us have periodically woken in a cold sweat from that nightmare in the course of our adult lives?

I sometimes feel that, especially around the December full moon, tax advisers do their darnedest to  induce such feelings in the populace with ‘Achtung!’ articles of what must be done  (but clearly can’t be achieved)  before drawbridges go up for the Christmas/New Year break.

475px-The_Scream 2

Don’t panic!

I only ever tried to panic a prospective client once. (I warned a foreign company that  they needed to get their VAT house in order to avoid risk of  criminal prosecution, they ignored me and went to an alternative firm that proffered soothing advice, and they were criminally prosecuted two years later).

So, allow me to preface my remarks on Israel’s  10 year tax exemption period for first-time and certain returning residents by stressing that they are not aimed at those whose benefits end in the next few weeks, but rather in 2019 and thereafter. People who arrived on their equivalent of the  Mayflower  in 2008 (or earlier) are either sorted out, or the best of luck.

Everybody – that is the entire Jewish world, the OECD and the IMF – by now knows that Israel has operated a territorial tax system for first-time and certain returning residents since 2008 (with retroactive force to 2007). The law states that a first-time resident or veteran returning resident is exempt for ten years from income produced or derived outside Israel or whose source is in assets outside of Israel, as well as capital gains from the sale of such assets. The problem is that (from my experience) many mistakenly believe that, as long as they don’t go to work on a kibbutz milking cows, they can forget about tax for ten years. In reality, even those who do not incur any Israeli taxation during the exemption period need to be prepared for the day at the end of the decade when they fall off the tax cliff.

OLIM-HADASHIM

New olim, yes. New residents, perhaps

First of all the good news. Despite the drafting of the law being as hopeless as much other tax legislation in the country, more than ten years down the road the  tax authorities seem to have made their peace with much of the excruciatingly inconsistent language, as well as the fundamentals of residence. Grammatical glitches appear to have been passed over unnoticed, and nobody seems to be bothered about the repeated careless use of the word ‘Oleh’ in pronouncements, aliyah not being a prerequisite for tax residence. 2018 saw the first annual filings of residents coming out of the ten years (for the 2017 tax year), and most of the reporting snafus will presumably be ironed out over the coming months. Similarly, some of the more heroic assumptions required as the assessee slowly glides out of the exemption period (there are special provisions for capital gains) can be expected to be blessed, or otherwise, by the authorities.

As people start to report, the authorities could take an interest in the exemption period, looking for amounts that should have been reported despite the exemption.

In any event, among the issues assessees need to be considering as the watershed approaches are:

  1. When did they actually become resident? Although, in terms of the wording of the law, residence under domestic law as opposed to treaty is an annual thing, the authorities have repeatedly made clear in writing that they interpret it as something that can change mid-year. So far, so good. The problem is that their pronouncements on when the ten years actually starts have made clear it is not necessarily the night they give you a funny hat and a flag at Ben Gurion airport if, for example, there was already a home in Israel and/or significant time has been spent in Israel.
  2. Are they sure none of their income was ‘produced or derived’ in Israel, and thus liable to tax? There have been rulings over the last decade concerning new residents working  with foreign companies from Israel ‘by remote control’ through internet, e-mail etc, or trading foreign securities from Israel. The tax authorities are operating an amnesty procedure until the end of next year – although if an anonymous request is desired, it has to be made by the end of this month (ouch!).
  3. Corporate structures abroad, while being convenient as long as Israeli taxation does not apply, may need reorganizing. That is something that generally needs to be done while the exemption is still in place.
  4. Decisions need to be made regarding whether to realize assets – significantly  parts of securities portfolios  – before the end of the exemption period, or to benefit from the only gradual linear increase in capital gains in the post-exemption period.
  5. Thanks to developing legislation since 2006, trusts are supposed to be largely tax neutral – but there are still some horrible jagged edges that can create nasty tax accidents . There are certain benefits to new-resident settlors or beneficiaries that soothe the pain as long as the exemption period lasts. The long-term future of such trusts needs to be considered.
nuclear

Public Service Announcement

I sincerely hope this hasn’t scared anybody. I prefer to think of it as a Public Service Announcement. Really.

Bad Cumpany

scaramander

‘Come, come Mr Bond’

If, like me, you have been wondering for decades what the European Parliament is there for, wonder no more. Following a recent vote, the august institution is considering  setting up an investigations unit to tackle two humongous European fraud schemes  named improbably  ‘cum-cum’ and ‘cum-ex’. The first warning that something was afoot came in 1992, and the fan turned brown in 2017, but the wheels of power turn slowly in Strasbourg. (Or was it Brussels? Or Luxembourg?)

For those without a Latin education, the schemes translate as ‘with-with’ and ‘with-without’. It would be nice to leave it at that, but I had better explain.

Both schemes revolve around dividends on stocks. A stock is cum-dividend when a securities buyer is destined to receive a dividend that a company has declared but not paid. That is the status quo (more Latin) until the date at which the stock trades ex-dividend – when the dividend will go to the seller. Thanks to lacunae (Latin noun – first declension nominative plural, like mensa/mensae) especially in German law, but evidently in about ten other European jurisdictions, bankers and the other usual suspects were (possibly still are) able to bleed national treasuries of scarcely imaginable sums.

The cum-cum smacks more of an old-style tax avoidance scheme than hardcore evasion. Stocks of German companies held by foreigners who were not eligible to  dividend witholding tax exemption were ‘lent’ (effectively sold with an agreement to repurchase , – but it isn’t written that way) to bona fide German banks shortly before a payment date. The stock went back at a lower price without the dividend. Naughty, but with loud protests that it only made hay while the legislators slept. There was one exemption, and the bank had a technical right to it.

Godfather

He knew how to make sure a secret was kept

Cum-ex was a far dodgier form of exploitation, which did not rely on foreigners. It did, however, require collusion and, on the grounds that ‘two people can keep a secret as long as one of them is dead’, it was bound to be found out eventually (having said which, the German and other authorities seem to have made gargantuan efforts to miss what was going on beneath their noses). Basically, a bank would ‘borrow’ stocks cum-dividend within two days of the dividend payment date and would sell them (short) to a third party. Delivery was required in two days, by which time the stock had gone ex-dividend. The procedure in force until 2011 in Germany (and heaven knows what is still happening elsewhere) was that the bank had to make a compensatory transfer between the seller and the buyer for the net after-tax amount of the dividend, and then issue a certificate of withholding to the buyer even though he did not actually receive the dividend. The theory went that the seller would no longer be entitled to that withholding as he had transferred the dividend amount to the buyer, and therefore would not receive a withholding certificate. Aye, and there’s the rub. The short seller of the stock was not the ultimate owner and had not suffered the withholding tax. The ultimate owner also received a witholding tax certificate (if handled correctly, the number of withholding tax certificates could be multiplied) enabling two or more ‘owners’ to cash in on the same tax benefit. This is not clever tax avoidance. It is clearly tax evasion. And it has cost European state coffers an estimated €60 billion.

mob

The words ‘company’ and ‘companion’ derived from the Latin ‘cum panis’ – with bread

But, at least we know we can now sleep safe at night in the knowledge that the European Parliament is on to it. It has only taken them 26 years. Rumour has it that MEPs are soon to issue a communique announcing the end of the Second World War. The suspense is killing.

 

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