20.07.2011

These cars are provided to help the employees do their work, but they tend to get used after work hours as well.

What happens if you owe excessive tax on deemed use of an employer-provided car? Recently an Israeli court considered this question.

These cars are provided to help the employees do their work, but they tend to get used after work hours as well.

How does car taxation work? How much car expenses can the employer deduct? And what benefit should the employee be taxed on? The Israeli tax regulations largely follow the UK precedent of prescribing fixed ‘‘usage value‘‘ on which an employee is taxed for private use of each type of car (Shovi Shimush). This is regardless of the actual private use of the car.

For example, here are the prescribed usage values for a few cars first registered and put on the road in 2011:

NIS 3.080 for Hyundai I 30 (product 0253, model 0151) with a list price of NIS 124,000

NIS 3,090 for a Mazda 3 (product 0588, model 0371) with a list price of NIS 124,500

NIS 4,040 for a Subaru B4 (product 0650, model 2021) with a list price of NIS 162,900

NIS 4,560 for a Mazda 6 (product 0588, model 0491) with a list price of NIS 184,000

The product and model numbers are found on the vehicle license document.

Currently, employers may deduct all expenses of cars made available to employees. In addition, the expenses of ‘‘operational vehicles‘‘ are fully deductible if the car is used to generate income but is not allocated to any specific employee.

Self-employed independent contractors will be allowed to deduct the higher of:

(1) total car costs minus the taxable car usage value, or

(2) 45% of the total car costs.

Note that non-deductible expenses (Odfot) in Israel trigger payment of a tax installment by the 15th day of the following month at the rate of 45 percent in the case of businesses and 90% of not-for- profit organizations. These rates are way too high given that the regular rate of company tax is now only 24%. Not-for-profit organizations include municipalities, charities and sports clubs.

And if the employee enjoys use of the car net of tax, the ‘‘usage value‘‘ is grossed up according to the employee‘s marginal tax rate and added to his gross salary. The employer pays the resulting tax and deducts the grossed up salary expense.

Is it simple? You‘ll get a short answer to that question from most payroll and accounting clerks in Israel.

Is it fair? What happens if the prescribed ‘‘usage value‘‘ seems too high in a specific case? For example, suppose an employer provides an employee with a new Mazda 3 in 2011 and they can prove that the private use costs no more than, say, NIS 2,000 instead of the prescribed usage value of NIS 3,090? Recently, an Israeli court considered that dilemma (Jerusalem District Court, Tax Civil Appeal number 131/08, Maaleh Adumim Municipality v. Jerusalem Assessing Officer No. 2). In that case a municipality provided cars to certain employees and security patrol vehicles to others.

At the time, there was a slightly different expense deduction formula in effect but the issues were the same. How much were employees taxed on and how much did the municipality have to pay a 90% tax installment on? The municipality cited two earlier precedents. In the case of Continental Bank Ltd vs. Land Appreciation Tax Director (Civil Appeal 2343/05, handed down July 6, 2010) the Israeli Supreme Court ruled: ‘‘Priority should be given to evidence of the state if things before applying an assumption or formula that may lead to the imposition of tax on profit that was not derived…justice requires tax to be true tax, that is to say tax based on the factual situation of the taxpayer.‘‘ The principle of true tax was also upheld in the case of Interbuilding Construction Company Ltd vs. Tel-Aviv 1 Assessing Officer (Civil Appeal 1527/97, handed down March 16, 1999). In this case, the Supreme Court ruled that a general formula in the Income Tax Ordinance (Sec. 18(d)) for allocating interest expenses between building projects pro rata to other expenses should only be applied in cases where a specific allocation of interest costs to projects is proven.

In the present case involving municipal vehicles, the Court ruled that private use of a vehicle does not have to be allocated according to a statutory formula if there was no such use in practice, having regard to the principle of collecting true tax.

With regard to cars placed at the disposal of certain employees, the Court ruled there was insufficient supervision over their use. Someone else should have verified the need for journeys, such as the gate-keeper, by checking with the relevant department, as well as spot checks via the GPS system in the vehicles. This is to rule out private journeys. Therefore, the Court upheld the Tax Authority‘s claim that the car usage logs were not sufficiently detailed and no check was made regarding private use.

As for the security patrol vehicles, although similar procedures were in operation, the Court accepted the municipality‘s appeal. It was proven that the vehicles were clearly labeled as security vehicles making private use difficult to be credible.

To sum up, if you can prove the actual cost of the private use of an employer-provided car is less than the prescribed ‘‘usage value‘‘, consider applying the above rules to cut the resulting Israeli tax liability.

As always, consult experienced tax advisors 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.