Your Taxes: Missing or fictitious expense invoices

Newcomers are often surprised to learn that Israel has detailed bookkeeping regulations and businesses must use accounting books and software approved by the Israel Tax Authority (ITA). Well-known packages from abroad are simply not recognized here. Even multinational groups with state-of-the-art accounting systems in California or elsewhere must apply for special approval to use them in Israel.

If you fail to record a receipt in approved books, or if the expense amount does not reflect the price of an acquisition or a service, the ITA can “disqualify” your books and assess you on income estimated to the best of their judgment.

The resulting tax is sure to be higher than you ever thought possible. If you don’t have the right accounting package, you could outsource the accounting to an Israeli accountant, and many do.

What about undocumented expenses?

The ITA has just published a circular titled “Support for Allowing Expenses and/or Costs Claimed.” It deals with missing or fictitious expense invoices.

Surprisingly, the circular says if you don’t have documentation to support expenses incurred or assets bought, all is not lost. It may still be possible to preserve the integrity of the expenditure requirements of the Income Tax Ordinance.

General expense deduction rules

The general rule is that expenses are deductible if they are incurred wholly and exclusively in the production of income and are related and integral to the process of generating the income. The bookkeeping regulations require that there be external documentary support, including invoices from suppliers and subcontractors. There should also be an external documentation file where the documents are kept in a way that permits records to be found.

The burden of proof is on the ITA if the books are not disqualified and on the taxpayer if they are. If the books are disqualified, the ITA can refuse to accept an expense deduction.

In the case of Hydrola Ltd. vs Tel Aviv-Jaffa Assessing No. 1, it was ruled that the taxpayer has primary responsibility for presenting relevant documents and records that support the expense. But in exceptional cases in which there are special circumstances, the deduction of expenses may be justified if alternative evidence exists.

What alternative evidence can be used for expenses?

The circular discusses at length the criteria for the ITA to assess a taxpayer lacking invoices that substantiate the existence and amount of an expense or asset, or a taxpayer whose books were disqualified for claiming VAT on fictitious invoices.

First and foremost, the assessing officer has discretion whether to accept or reject alternative evidence. He should apply his experience and use the resources at his disposal for estimating figures. The assessing officer will also consider the following: • Is there evidence the expenditure was incurred? For example, did a builder build something on a building site? Were products used as raw materials or sold? •Was payment made, for example, by check, bank transfer, etc.? Payment in banknotes will be harder to prove, and the burden of proof is on the taxpayer.

• Did the other party report corresponding income? • Is there a signed agreement or contract? • Review of any valuation; for example, an insurance survey, loan-collateral review by a financial institution.

• For fixed assets acquired in prior years, is there an audited fixed-asset schedule for tax purposes? • Records at other official bodies in Israel or abroad; for example, land-betterment levies and transfer taxes.

• Corroborative declaration by subcontractors who report corresponding income.

• Check the subcontractor’s fee by add a customary profit margin to salaries paid by the subcontractor.

• Check major shareholders’ accounts to see if amounts spent were really pocketed; if so, such amounts received should be grossed up for Israeli tax purposes.

• Check pricing to market surveys.

What about VAT? The circular points out that there may be cases in which an invoice is acceptable for income-tax purposes but is not acceptable as a tax invoice for VAT purposes. For example, the invoice issuer is not registered as an “authorized dealer” for VAT purposes, or the invoice lacks some of the information that should appear on a tax invoice.

In other cases, the invoice may be unacceptable for income tax and VAT purposes if it is a fake or the amount or parties involved are different than those stated.

What should you do?

Always ask for a tax invoice from suppliers. If you lost it, ask for a copy certified by the issuer as true copy (ne’eman lamakor). In any event, you should check the supplier is listed on the ITA website and whether you should withhold tax from the payment to the supplier. You’ll need their identity number for this.

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

leon@hcat.co

Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.