It is an open secret that many Israeli businesses selling in or into the United States may not be fully complying with their US state and local (subnational) tax obligations – and certainly are not engaging in basic tax planning.
Anecdotal evidence suggests three reasons for this: bad tax advice; a yihiye b’seder (it’ll be okay), fly-below-the-radar approach to tax management; and the failure of the states to defend their interests through audits and enforcement.
However, two recent developments portend a shift in the states’ attitudes and, consequently, require the maturation of Israeli businesses’ tax planning and compliance.Comparison
In April, the Israel Tax Authority issued Circular 4/2016, which asserts tax jurisdiction over foreign businesses having a “significant digital presence” in Israel.
(The circular does not define “digital services.”) In the United States, many states have been litigating similar jurisdictional concepts (and are regularly succeeding) under theories of the economic presence of the remote business or the presence of an Internet representative in the jurisdiction.
Until now, the states’ efforts have been focused on businesses with significant physical presence somewhere in the US.
However, Circular 4/2016 plays directly into the states’ hands by legitimizing arguments they have long made and by applying those arguments across international borders. Furthermore, Israel’s initiative against US businesses can be expected to trigger a response in kind from the states in which those businesses are located.
That means state revenue departments can be expected to attempt to reach Israeli companies making remote sales into their state. This does not mean that the states will ignore similar businesses from other countries. However, given that many noncompliant Israeli companies already have actual physical presence in the states, an increased profile for Israeli sales into the US is bad news.Recent example
Indeed, a month before the issuance of Circular 4/2016 (while the circular was still in draft form), the US federal government unsealed a grand-jury indictment against an Israeli businessman and arrested him.
The disputed business involved the sale of skin-care products in shopping malls.
The illegal activities alleged included tax evasion, employment of illegal workers and related conspiracy charges. The federal grand jury also indicted nine others, including at least six more Israelis, on two to 20 counts of criminal conduct.
It is likely that the federal indictments are just the start of the defendants’ problems, as the business operated in at least seven states. Any or all of these states and other subnational jurisdictions may pursue audits and enforcement proceedings of their own, including for taxes other than those at issue federally. And because the indictment alleges the making of unreported payments to employees in cash, goods and gift cards, multistate tax issues may figure prominently in any additional criminal charges against these Israelis. Furthermore, civil enforcement (collection of taxes, interest and penalties) is at least as likely against both the business and the individuals who held managerial roles.The aim
As always, a primary objective for federal and subnational tax jurisdictions is to shift tax obligations to nonvoters to the greatest extent possible. Among the most vulnerable nonvoters are foreign-based businesses whose only “planning” against tax liability is their presumed low profile.Get protected
Israeli companies can and should take action to protect themselves. First, they should disregard “don’t worry” advice from anyone lacking expertise in American federal, state and local taxation.
Second, the companies should obtain competent federal and state tax counsel to estimate the likelihood that the business is liable for prior periods’ unpaid taxes, and then quantify the exposure.
The businesses will want expert advice on approaches for eliminating or at least reducing the exposure. Third, these businesses should structure their activities to reduce their federal and subnational tax obligations and liabilities.
This third point bears emphasizing, as the yihiye b’seder philosophy of businesses and advisers has kept Israeli businesses from doing actual, legitimate federal and subnational tax planning. With the issuance of Circular 4/2016 and the arrest of the Israeli national, one can only hope that the days of fly-below-the-radar tax management will end post-haste.Who is held responsible?
For sales, use, withholding and certain other taxes, states and localities have the right to collect a business’s unsatisfied obligations from the business’s owners, management personnel and even nonmanagement employees who were involved in relevant finance or tax functions. This is known as “responsible party” liability. It is a tool regularly used in the US when a business has acted irresponsibly or when enforcing collection from the business is difficult.
A 2013 study found that over a prior 30-month period, no fewer than 17 states litigated responsible-person cases, and several states litigated two or more responsible- person cases. Moreover, the states usually won these cases. Significantly, the reported decisions undoubtedly represent a small minority of these collection actions. Most disputes are resolved quietly.
Obviously, no one wants to pay someone else’s taxes. But a business that fails to tax plan risks being held responsible for taxes not paid by its customers and further risks having its management held personally responsible for the customers’ unpaid taxes. Now, after the issuance of the Circular 4/2016 and the indictment described above, Israeli businesses must be aware of their increased profile in the US and act responsibly.
As always, consult experienced tax advisers in each country and state at an early stage in specific cases.[email protected] [email protected]
David Fruchtman is the chairman of Rimon PC’s state and local (subnational) tax practice.
Leon Harris is a certified public accountant and tax specialist