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The Israeli Supreme Court addressed the tax assessment appeal procedure. Briefly, the taxpayer's tax return is a considered a self-assessment, but the Tax Authority may issue its own "best judgement" assessment if it has reasonable grounds to believe the taxpayer's return is wrong (Section 145 of the Income Tax Ordinance). The taxpayer may appeal the assessment within 30 days after receipt, in which case the Tax Authority generally has up to one year to reach agreement with the taxpayer or else issue an order stating the tax due. Otherwise, the taxpayer's appeal is deemed to be accepted. (The one year deadline is extendable up to four years after the end of the tax year in which the tax return was filed, if later.)
What happens if the Tax Authority claims it issued a tax order but doesn't send it to the taxpayer within the deadline period? The Supreme Court recently ruled that the Tax Authority is not considered to exercise its power to issue a tax order before the order is brought to the taxpayer's attention. It is not enough if only the tax assessing officer knows of the tax order. This is an important development.
In other words, a deadline is a deadline and the Tax Authority cannot buy time by sitting on a tax order. Furthermore, the Supreme Court ruled that this principle has retroactive effect for any ongoing proceedings in which no final decision has yet been delivered. (Moshe Sami & Ikafood Ltd. cases 5954/04 and 1857/05 decided on 22.4.07).
In a separate case before the Jerusalem Magistrates Court, two brothers apparently thought they had reached a settlement at a meeting with the Tax Authority in May 1998. They were accompanied by a tax adviser. Before the meeting, it seemed that one brother owed tax for several years up to 1996 of around NIS 625,000, the other brother owed around NIS 300,000 and the total including penalties stood at around NIS 1,210,000.
According to the brothers, the agreed settlement required them to pay only NIS 500,000 by July 14 of that year and the remaining balance for those years would be written off by the Tax Authority. The brothers duly paid the NIS 500,000 only to find the remaining balance was not written off; instead the brothers had their assets frozen by the Tax Authority.
Where was the agreement recorded? In hand-writing on a piece of computer print-out paper retained by the Tax Authority.
So the brothers applied to the court for redress. In the court hearing, the Tax Authority claimed the agreed amount payable was NIS 500,000 from each brother, the agreement at the meeting required final approval from additional people in the tax office and in any case, the law did not allow the tax authority to reduce the principal amount of tax due (NIS 925,000).
The court had to determine what the parties had agreed - a King Solomon task - and it did. According to the judgement, two tax officials had trouble remembering what was discussed at the meeting - so they couldn't deny the taxpayers' claim. And the taxpayers must have had a reason for paying the amount of NIS 500,000 to the Tax Authority.
Also, the court reviewed related documentation relating to the decision of the Income Tax Commission as reported in handwriting on the taxpayers' request for a reduction of interest, indexation and penalties: "Following many discussions on the subject and after payment in total of NIS 500,000, the writing off of balances for 93-96 inclusive is approved." The Court interpreted this to mean only one payment of NIS 500,000 was required by the Tax Authority in its decision, not two.
Furthermore, the brothers actually paid in total NIS 446,000 whereupon the tax authority offset a credit tax balance of one of the brothers in the amount of NIS 64,000. This indicated that the tax authority accepted the NIS 500,000 settlement and treated the brothers as being in partnership.
There were additional complicating factors in this case, but the court recited the general principle that a public authority must behave in good faith, honesty and decency with a citizen. On the other hand, the law actually did not allow the Tax Authority to reduce the tax debt below the amount of principal - NIS 582,000 according to the judgement.
Therefore, the court ruled that the taxpayers must pay a balance of NIS 82,000 only (not NIS 500,000) and ordered the Tax Authority to pay the court costs as well as the taxpayers' legal costs in the sum of NIS 20,000. (Yitzhak & Eliezer Cohen v. the State of Israel, 008423/03 decided on 26.2.07).
The writer is an International Tax Partner at Ernst & Young Israel.