Tax Break

John Fisher, international tax consultant

Archive for the tag “Israeli taxation”

The Judgment

Where should I go to work?

To me, Israel’s National Insurance Institute is one of the last bastions of socialism in our essentially free-market economy. Despite legislation by the freely elected Knesset, it has always appeared to operate according to its own rules. Indeed, over an international tax career in this country spanning three decades, I was so confused that, when I would finish dealing  with the tax consequences of anyone going to work abroad  (and in this Start-up Nation, LOTS of Israelis go to work abroad), I would reach a point where I would simply tell them to visit their local NII office, provide a full explanation of their plans, and accept whatever they told them to do. That invariably resulted in a minimum (and I mean, minimum) monthly payment. When I did try to wade in – once sending not one, but two official letters for a ruling to two relevant addresses – I received two diametrically opposed answers.

The saddest thing of all is that the law is perfectly clear on the matter – an Israeli resident working abroad (unless governed by a Totalization – avoidance of double payment – Agreement between the two governments) is liable to full national insurance contributions on his or her income.

For decades the law might have been law, but bureaucracy was bureaucracy, and – as in any good socialist society – bureaucracy trumps law.

An appeal has just been heard to a case that was brought before a regional labor court back in 2017. The result is Kafkaesque. Hold onto your caps, comrades.

‘I am a faceless bureaucrat’

The case involved an individual who had gone to work abroad in 2009 and 2010 for a foreign employer. He did what any good free-marketeer (or even socialist) would have done at the time, and – on his tax advisors’ advice – trundled off to his local branch of the People’s Republic of National Insurance. They told him – as they did to countless others – that he would be required to pay minimum monthly payments during his sojourn abroad.

Four years after his return he received a (metaphorical) knock on the door from the men in raincoats telling him to pay up maximum (not nominal) amounts on the time abroad. The men in raincoats – as opposed to the bureaucrats manning the local offices of their Institute – clearly knew the law. The individual went to court.

In 2017, the labor court found in favor the little man. The judge sympathized with the plaintiff’s argument that, whatever the law, the clear practice of the Institute at the time was to charge the minimum amount. It even turned out that, when the NII dealt with the intrinsic problem in 2014 (a year conveniently sandwiched between the transgression and the claim for back payments) the reason for their cockeyed policy became apparent. There are three classifications for National Insurance – self-employed worker, employed worker, and not employed and not self-employed worker (‘worker’ is in the original, comrade). The first and last are required to pay over their own contributions; the second transfers obligation to pay to the worker’s employer. Foreign employers couldn’t be expected to pay the contributions, so workers in foreign employment were shoe-horned into the third category, which called for minimum payments. The judgement also made a big deal of the amount of time it had taken the NII to get to the individual, given that he had come clean prior to taking up the position.

Well, the appeal at the end of July, which took two long years to be heard, overturned the lower court’s position. The fact that the National Insurance Institute didn’t know its head from its backside was not a reason to relieve the individual of the need to pay – even years after the event. The Kafkaesque bit was that the judge even implied that – knowing the correct law – the individual should have come forward, reported, and paid. (In practice, the income tax authorities share the income tax assessment with the NII, and that is how liability is determined countrywide. Strictly, however, the reporting of that income to the NII is incumbent on the assessee).

Now, I don’t know the last time this judge turned up at a government office and told the bureaucrat behind the desk that – despite a clear monthly liability – they have got it wrong and they demand to pay more. I see the following scenarios:

  • The bureaucrat telling them in no uncertain terms to kindly stop wasting their time while looking around for the hidden Candid Camera.
  • The bureaucrat opening up an investigation into the individual’s affairs to find out how much they REALLY owe.
  • The bureaucrat calling the men in white coats (as opposed to raincoats, this time) to cart the individual off to a place their employer will never find them.

In Yiddish folklore, there is a town full of fools called Chelm.

Who stole the punch line?

Not all double acts know they are funny

I am rarely amused by the pronouncements of the Israeli tax authority – au contraire, they often rile me. But, last week a public ruling had the effect of diverting my mind to the comedy double acts that had their origins in America’s Vaudeville and Britain’s Music Halls. Laurel and Hardy, Abbott and Costello, Morecambe and Wise, The Two Ronnies. The list goes on and on.

The ruling concerned an oldie but goodie in the international VAT sphere. It contained absolutely nothing new (I will rant about that shortly – I am still at the amused stage), but did serve as a reminder to international tax advisors everywhere (in Israel) that corporate tax planning cannot be done in isolation. Corporate tax and VAT are a double act, with the direct tax as the funny guy, and the indirect tax as the straight man. If an international tax advisor does not deal with the two in tandem, they might just as well send in the clowns.

stan-laurel-1

I just don’t get it

There is a peculiarity in Israeli VAT law not shared – to the best of my knowledge – by the EU or other major operators of the tax. Services provided to foreign residents who are outside of Israel generally attract zero-rate VAT (a doublespeak way of saying there is no VAT). However, there are exceptions – particulary where the service agreement benefits, in addition to foreign residents, Israeli residents. And, as the 17% VAT is on the gross amount, and as the foreign residents cannot reclaim the VAT in the absence of a taxable presence in Israel, advisors need to pull their hair out thinking of structuring solutions.

The matter considered by the authorities involved a local company operating a Hebrew website to provide marketing services (and a little bit more) to foreign suppliers of goods. They charged a commission  for this service to the foreign suppliers. The  authorities were asked to rule that the charge should be zero-rated, as it was a service to a foreign resident. Despite also being  to the benefit of the Israeli resident customers,  the law has a  Get Out of Jail Free card –  VAT is zero-rated  if the marketing charge is included as part of the customs value of the subsequently imported goods (it wouldn’t work for imported services, and hence the need for careful structural planning in this sphere).

The ruling makes the zero rate conditional on proving, inter alia,  that the price of the imported goods is included in the import price. “Nothing wrong with that,’ I hear you mutter. Aye, but there’s the rub. There is a reason the tax authority has a ruling process – it provides certainty where there was doubt. And there is a reason the tax authority publishes condensed and sanitized versions of those rulings – so that the certainty exists across the board. All very noble.

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Have you declared the marketing charge?

The published ruling provided no information that was not known already. The law – as represented in the ruling – is entirely clear. What has never been clear – and why I read this document with keen interest – is: ‘What constitutes proof that the service is included in the value of the imports?’  ‘Ah! I hear you say; it is obviously included because it is one of the costs directly related to the sales to Israel’. All I can say is, that it is at times like this that you need a sense of humour. In discussions with the authorities over the years, they didn’t necessarily think it was so obvious if there wasn’t a specific reference in the import documentation to that element of cost (‘included in the import price’ – get it?)

I want to see them get out of that one.

So, if – as I suspect – the ruling request was seeking clarity on that issue, either it was provided and then excluded from the published summary, which would be scandalous; or it was not given at all, which would mean the whole process was a waste of taxpayers’ money.

Either way, it’s time for the tax authority’s scriptwriters to have a rethink about their material.

Comfort and joy (for some)

New Zealand

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.

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