Your Taxes: Income tax vs national insurance

The final income-tax assessment will determine not only the amount of income but also the type of income derived by “insured” taxpayers.

By LEON HARRIS
Your Taxes_311 (photo credit: Thinkstock/Imagebank)
Your Taxes_311
(photo credit: Thinkstock/Imagebank)
As recently reported, Roy Saunders, who heads International Fiscal Services in London and edits International Tax Systems and Planning Techniques, believes that “we wouldn’t mind being asked [or obligated] to give if we understood where our tax revenues were going.”
Therefore, specific taxes should be applied to specific purposes – social security, roads, affordable homes, etc.
This is not completely new. In many countries, social security/national insurance taxes exist alongside income tax, VAT, and so forth.
But what happens when the different taxes clash? In the international arena, there are double-tax treaties and foreign tax credits (or exemptions) in most countries.
But in the domestic arena there are no such treaties or credits – so what happens in cases of domestic double tax? A recent case in Israel, in the Haifa Region Labor Court dealt with a head-on conflict between Israel’s income tax and national insurance rules (Hausa Gas Station Ltd., David Kahana & Uri Katz v. The National Insurance Institute, National Insurance Case 2772-08, handed down January 31, 2012).
The Facts:
In March 1999, an Israeli company which owned a petrol station started leasing it to the Paz Oil Company Ltd. (“Paz”) for eight years initially, later extended to 49 years. Paz is a major oil company in Israel which proceeded to operate the petrol station.
In the years 2002-2004, the shareholders of the Israeli company each drew a salary from the company, on which Israeli income tax and national insurance was paid as normal.
However, in 2005, the Israeli Tax Authority rejected the salary expense and re-classified the payments as dividend. After protracted negotiations, on November 29, 2006, the shareholders signed an “assessment agreement” with the Israeli Tax Authority treating most of the payments as dividend.
The shareholders then requested that the National Insurance Institute accept the tax assessment agreement, i.e. treat most of the payments as dividend instead of salary for National Insurance purposes, and refund the resulting excess national insurance contributions paid. The National Insurance Institute (NII) refused. Consequently, the shareholders appealed to the Court to grant a refund of the national insurance contributions paid.
What are the issues?
The Court’s analysis is quite instructive. The first question was to decide what the issues are. The Court decided there are two main issues.
1. If the shareholders aren’t really employees, how should they be classified by law? 2. What are their rights under the law? And doesn’t the NII have a say in each case in classifying the “insured” individual and the classification the insured is claiming?
What is National Insurance?
The Court began by pointing out that it is mandatory to be insured and to pay national insurance contributions.
The law defines the relationship and it is not a contractual one. The citizens of Israel don’t sign an insurance contract with the NII. It is a statutory relationship.
The Court cited an earlier case which stated that: the distribution of various social security benefits by law cannot be done without payment of national insurance contributions by all the “insured” according to their liability (Renaissance Hotel v. National Insurance Council, National Labor Court judgement 1349/01 of August 14, 2005).
According to the Court, the real questions are how to classify the “insured” under the National Insurance Law and which source is used to pay the national insurance contributions? This matters because by law, salary earners don’t pay national-insurance contributions on dividend income.
The Judgment:
The Court reviewed earlier judgments for general guidance. For example, the National Labor Court ruled that “The key for determining the amount of national-insurance contribution payable is the income tax assessment.” In that case, the Tax Authority didn’t accept that the taxpayer’s income was capital in nature (Meulam v. National Insurance Council 82/09).
Accordingly, the Court ruled that the appellants, in this case the “insured,” were not employees and they should be allowed to present documentation to the National Insurance Institute showing what their status is – self-employed or non-employed (the status used to impose national insurance contributions on students and investors).
Comment
The “insured” cited Section 345(b)(1) of the National Insurance Law (Consolidated Version), 1995, which states: “Income in the current year shall be determined according to the final income tax assessment…” This judgment tells us that the final income-tax assessment will determine not only the amount of income but also the type of income derived by “insured” taxpayers.
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.