taxes good 88.
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In Israel, it has long been standard practice to obtain advance tax rulings before completing a big deal - they are sometimes referred to as "pre-rulings." The aim is to reduce uncertainty, avoid double taxation and/or avoid taxation on "paper gains" such as share-for-share transactions or employee options.
The Israel Tax Authority (ITA) is also prepared to rule on other tax matters such as transfer pricing (see below), tax treaty issues, VAT aspects and so forth. The ITA has even begun to publish anonymous summaries of rulings it has issued. Rulings may be partly factual, partly interpretative of the law, but always within the confines of the law - the old British custom of "extra-statutory concessions" are precluded by Section 245 of the Income Tax Ordinance.
An amendment to the Income Tax Ordinance, introduced in 2006, lays down formal procedural rules regarding rulings. Taxpayers may apply to the director of the ITA for a ruling regarding the liability to tax, the tax result or any consequence thereof with regard to an act performed or income, profit, expenditure or loss that the taxpayer incurred.
The application must be submitted before the due date for filing the annual income tax return concerned (or before the execution of a transaction in real estate and VAT cases).
The application must contain relevant material details, documents, confirmations, opinions obtained, declarations, valuations, agreements or draft agreements if no final agreements have been signed.
There are generally no time limits for issuing a ruling. Ruling conditions or ruling time limits may be stipulated. The tax director may issue or refuse to issue a ruling or refer the matter to an assessing officer for a reply.
The applicant must be given a reasonable opportunity to be heard. The ruling cannot be appealed but the existing objection process can be applied to any ensuing assessment.
Note that an application may not be withdrawn without the tax director's permission. The application may be anonymous but the ruling will only be issued after the applicant is identified.
Any ruling binds the tax director, unless the information or documents submitted were incomplete false or "if the circumstances relating to the ruling have changed." If the ruling was issued by agreement, the applicant is also bound by the ruling, unless the act concerned was not carried out.
The tax director may charge a fee but usually does not at present, except in certain merger and acquisition cases.
What about transfer pricing, that is, the pricing of transactions between related parties? This can be a major ongoing headache for multinational groups.
Any party to an international transaction between related parties (defined very broadly) may apply to the director of the ITA for an Advance Pricing Agreement (APA) confirming that the price of the transaction or a series of similar transactions is on market terms. The APA application must be accompanied by all material facts and details of the transaction(s), the method for determining the price, as well as any relevant documents, confirmations, opinions, declarations, valuations, transaction agreement or draft agreement, and any other documents or details requested by the director.
The director must issue his APA ruling and grounds within 120 days after receiving all the above documents, but within this period he may notify an extension of the period, for reasons that will be recorded, up to 180 days. If the director does not respond within this period, the taxpayer's application is deemed to be confirmed.
What happens if the taxpayer changes his mind about a ruling? Since 2006, the law has provided that if the ruling was given by agreement, the applicant must honor its terms and conditions, unless the act that is the subject of the ruling is not performed, or no income was received or no expense was incurred regarding which the application was made (ITO Section 158F(b)).
This was reinforced by a recent case in the Supreme Court (Ehud Aloni vs Kfar Saba Assessing Officer, Tax Appeal 1804/05, January 31, 2008). In this case, a taxpayer was a shareholder in a company that made an exit - it was acquired by a US publicly traded corporation in exchange for stock in the US corporation that was frozen for a period. Since the exchange was taxable immediately but the value wasn't yet clear, the ruling allowed the value to be based on the proceeds from the subsequent sale of stock in the US corporation or its market price 24 months after the exchange, whichever was first. The resulting gain would be taxed at the full rate (apparently 50 percent then) rather than 35% (then applicable to foreign securities). In the relevant year the taxpayer filed a tax return reflecting the ruling, but later changed his mind and filed an amended tax return disregarding the ruling. This was apparently due to a sharp rise in the US corporation's stock price, to the taxpayer's disadvantage.
The Supreme Court ruled: "The parties held negotiations that resulted in a binding agreement from which the appellant (taxpayer) cannot withdraw.... The appellant chose to adopt the arrangement, signifying his acceptance of it. The signed agreement binds the appellant and the (tax) authority, so the appellant cannot cancel the agreement by amending his return."
The case was based on events that occurred in 1999-2000, and the judgement based itself on contract law principles. The 2006 amendment would appear to put beyond doubt that there is no going back on an Israeli tax ruling.
And what happens if another taxpayer gets a better ruling than you do? A recent Haifa District Court case (Income Tax Appeal 589/04 - Ariela and Moshe Shahar vs Hadera Assessing Officer) requires the ITA to avoid inequality. The case dealt with stock options of a well known company. The judge ruled that an executive body such as the ITA cannot reach an arrangement that discriminates between different taxpayers in similar circumstances and prevent the arrangement being applied to one of them. Furthermore, such arrangements should not be signed and concealed.
Leon Harris is an international tax partner at Ernst & Young Israel.
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