How do you stop the Israel Tax Authority from behaving like a neighborhood bully? Does it have carte blanche to interpret the law its way every time? Can it read things into the law that aren‘t really there? In short, is the ITA an 800- pound gorilla that just won‘t leave you alone?
Not exactly. The Supreme Court has just handed taxpayers a major gift in the case of Tel Aviv 5 Tax Assessing Officer v. Sarel Shabaton (Civil Appeal 8958/07, handed down August 18).
In this case, the taxpayer received severance pay upon retirement and was allowed to spread the amount received over a number of tax years for Israeli tax purposes under Section 8(c)(3) of the Income Tax Ordinance. But the taxpayer also happened to be disabled and was exempt from tax on income up to a certain amount prescribed in Section 9(5) of the Income Tax Ordinance.
For example, in 2011, people certified as being 100 percent disabled (or 90% in certain circumstances) for 365 days or more are exempt from tax on employment-related or business income of up to NIS 579,600 per year, pro rated by reference to the number of days‘ disability.
If they are disabled for 185- 364 days in a tax year, they are exempt on such income, but no more than NIS 69,480 per year, pro rated by reference to the number of days‘ disability.
The issue in this case was whether the disabled taxpayer could claim both reliefs; i.e., spread the severance pay over a number of years and claim the disabled person‘s exemption every year up to that year‘s limit.
The ITA didn‘t think so and sought to grant the exemption for one tax year only. Furthermore, the ITA claimed it has discretion to decide things, because Section 8(c)(3) states that the director of the Tax Authority ‘‘is permitted… to allow the spread over a different period… on terms that he determines…‘‘
The Supreme Court firmly rejected the ITA‘s claims. First, the court ruled that ‘‘the balance of facts leads to the conclusion that Section 8(c)(3) of the law, in its present version, permits a genuine substantive spreading of income received by the appellants by way of severance pay to later years, while facilitating in each of those years the annual exemption that the appellants are allowed under Section 9(5)…‘‘
What about the tax director‘s discretion? Can the tax director make the spread of income over future years conditional on the taxpayer waiving the disabled person‘s exemption? In answering this question, the Supreme Court referred to both Israeli constitutional law and Israeli administrative law.
With regard to constitutional law, the court cited Section 1 of the Basic Law: The Economy of the State, which states: ‘‘Taxes, compulsory loans and other compulsory payments shall not be imposed, and their rates shall not be changed except by law or in accordance with it.‘‘
Therefore, according to the court, this section cannot be read as allowing a variation of taxes by pure administrative acts, and imposing conditions falls within this category.
In this case, the taxpayer had to apply to the ITA to get severance pay spread over several tax years. This was a matter involving administrative law. The court accepted that the authority for giving an exemption, relief, reduction and so forth includes also giving them partially or subject to conditions.
But the Supreme Court ruled that administrative authority cannot be used to harm human rights (which requires an express arrangement) or impose monetary costs not expressly provided for in the relevant legislation.
Furthermore, according to the court, Section 8(c)(3) does NOT say that granting this relief means forfeiting something; this amounts to unlawful discrimination. An administrative authority cannot with one hand give (by approving the spreading) and take with the other hand (the benefit of the spreading).
On the other hand, the court ruled that Section 8(c)(3) can be used to limit the exemption or the spreading over the years if, for example, the severance pay is increased in a contrived fashion to fit in with the exemption limit. But that wasn‘t relevant in the present case.
TO SUM UP
The Supreme Court came down firmly on the side of the taxpayer on constitutional and administrative grounds. The ITA has no authority to change taxes or restrict statutory tax breaks unless the law expressly allows this.
EXAMPLE CONCERNING OLIM
Let‘s hope the ITA will not read things into the law that aren‘t there. For example, on January 18 the ITA issued a circular (1/2011) regarding tax benefits for new and returning residents. Briefly, new residents are granted an Israeli tax exemption for 10 years regarding non-Israeli source income and gains. The same applies to ‘‘senior returning residents‘‘ who resume residence in Israel after living abroad for 10 years.
For some reason, the aforementioned circular indicates an ‘‘exception‘‘ for income derived outside Israel during a short period relative to activity in Israel and that such income should be deemed to be derived in Israel. The circular even contains an example regarding Maya the model, a senior returning resident, who is active in Israel and spends ‘‘no more than 40 days‘‘ abroad working as a model. the circular claims the income derived abroad is taxable in Israel.
However, there is no such ‘‘exception‘‘ in the relevant tax legislation, and the circular‘s guidance would appear to be null and void on constitutional and administrative grounds pursuant to the Sarel Shabaton case. It remains to be seen whether the ITA will reconsider its position. Any readers in a similar position are invited to contact me at the e-mail address below.
As always, consult experienced professional advisers in each country at an early stage in specific cases.
Leon Harris is a Certified Public Accountant and tax specialist at Harris Consulting & Tax Ltd.