Court hammers tax persecution

Areturning resident taxpayer has scored a resounding victory in the District Court against nasty heavy-handed tactics applied by the Israeli Tax Authority (ITA) in Yaron Meir vs Eilat Assessing Officer, Civil Appeal 21579-0120, April 17, 2022.

MAIN FACTS

The taxpayer left Israel in May 2007 to live in Kenya, then Tanzania, with his family. He went into business with three other non-residents to exploit in Tanzania a license from an unrelated Canadian public company to dye gasoline in order to prevent black market dealings. The operation in Tanzania had 80 employees. It was organized as a Tanzanian company held by a British Virgin Islands company in which the taxpayer had a 16.33% interest (rising to 24% when one of the other three died). The taxpayer returned to reside in Israel in July 2013 after living abroad for more than six years.

THE MAIN ISSUE

Section 14(c) of the Income Tax Ordinance (ITO) grants an exemption from Israeli tax to returning residents who resided at least six years abroad. The exemption runs for five years regarding pensions, royalties, rent, interest and dividends derived from assets acquired while they were residing abroad (and for dividends and interest on foreign securities lodged in a specific bank account while they resided abroad). This is not as generous as the 10-year exemption for any foreign income or capital gains had they resided abroad at least 10 years.

In 2016, the ITA national assessment division began investigating the case in depth. In 2018, the taxpayer felt so persecuted by the ITA that he moved from Israel to live in New Zealand with his family and didn’t return.

The ITA persecution apparently included freezing the taxpayer’s assets, inaccurate recording of answers in negotiations, demanding documents (which he claimed he didn’t have) with a threat of fines or prosecution, followed a day later with a surprise visit by ITA officials at his home. They were looking for files showing management of the BVI company, as the taxpayer claimed a deduction of home expenses against fortnightly dividends from that company.

The ITA claimed: (1) the dividends from the BVI company were really business income (because of the expenses), which was ineligible for the five-year exemption, and (2) the taxpayer didn’t really reside abroad for six years.

COURT JUDGEMENT

The court accepted the taxpayer’s appeal against an ITA tax assessment for NIS 9 million, awarded him costs of NIS 100,000 (a high amount that sends a message) and criticized the ITA on many grounds, including the following:

Claiming an unconditional exemption for returning residents under Section 14(c) of the tax law was legitimate tax planning intended by the Knesset.

Claiming a legislated exemption does not justify a surprise home visit, asset freeze and reclassification as business profit.

Disproportionate and unreasonable use of search powers while assessment procedures were still in progress after the taxpayer already provided the information needed (financial statements, bank statements, dividend confirmations, etc).

The surprise visit contravened Tax Circular 21/2001 that says home visits must be with prior approval from the taxpayer, to inspect bookkeeping, not other things.

The ITA could not use a surprise home visit to bypass the taxpayer’s accountant (ITO Section 135(1)(a)). The accountant had requested all communications be through him only the day before.

The court ruled the payments were dividends factually and legally. The taxpayer didn’t provide any services for them. Directors don’t have to be paid directors’ fees.

Dividends are recognized in the Israeli tax system.

The frequency of payments here evidences the profitability (of the Tanzanian operation).

The ITA changed its mind what the payments were – first earned income, then business profit, making it difficult for the taxpayer to respond.

If the ITA thought the home office expenses were disallowable, the ITA could have disallowed them.

The ITA conceded later in the process that the taxpayer resided abroad over six years.

The ITA didn’t even try to claim taxable “control and management” over the BVI company (presumably as the taxpayer was a minority shareholder).

COMMENTS

It remains to be seen whether the ITA will appeal the decision.

In our experience, such rough stuff is avoidable by: (1) selecting an accountant with international experience, (2) forming an Israeli consulting company to pay tax on the Israeli portion of the activity only.

In a separate case regarding eligibility for a disability tax exemption, the Supreme Court ruled the ITA cannot impose taxes, change its rates or harm human rights except as expressly provided by law (Sarel Shabaton 8958/07 of August 18, 2011).

As always, consult experienced tax and investment advisers in each country at an early stage in specific cases.

leon@h2cat.com