The general rule regarding expenses is that they
are deductible for Israeli tax purposes if the expenses are incurred
wholly and exclusively in the production of taxable income (Income Tax
Ordinance Section 170).
may sound familiar to British and British Commonwealth
readers, as it
was inherited from UK tax law thanks to British mandatory rule in
1917-1948. More recently, an Israel
i lawyer, Vered Perry, scored a
major victory in the Israeli Supreme Court, which ruled that her
child-minding expenses were deductible, as they were incurred in the
production of taxable income (Civil Appeal 4243/08 of April 30, 2009).
The Supreme Court specified a complete set of rules in this regard.
The Vered Perry case
The judges in the Vered Perry case ruled that child-minding was
deductible but not education or meals, as they benefit the child, not
the mother. Therefore, for simplicity in such a mixed case, the Supreme
Court ruled as follows: child-minder expenses (metapelet
) - 100 percent deductible; afternoon nursery (tsaharon
) - two-thirds deductible; all-day kindergarten (maon
- two-thirds deductible if meals are charged separately, otherwise 50%
deductible. These expense deductions would be split 50-50 between the
father and the mother.
However, the Perry case caused consternation in the
Finance Ministry: everyone with children would start claiming similar
deductions going forward and also going back as far as the statute of
limitations allows (generally three years after the end of the year in
which a tax return is filed). The result would have been billions of
shekels in tax refunds now and reduced tax receipts in the future.
Nature intended us to have children and a big tax refund would add to
This result would have wreaked havoc on the government's
finances, but not any more. On July 13, 2009, the Knesset
Amendment 170 to the Income Tax Ordinance, and it was published at
lightning speed on July 16, 2009 (Book of Laws 2202). The amendment has
two main parts.
Expense deduction negated
First, the amendment negates the Vered Perry case decision by
clarifying what is NOT deductible, namely: "Expenses that are not
expenses connected and integral to the process of producing income -
including home expenses, private expenses, private expenses, expenses
incurred in reaching the place of work and back again, and expenses
incurred on the 'treatment or minding' of a child or other person."
"Treatment" apparently refers to the kindergarten experience that
Israeli infants thrive on.
"Expenses connected and integral to the process of producing
income" are tightly defined as "expenses integral to the natural
process of producing income and the natural make-up of the source of
income, and representing an inseparable part thereof." The aim is to
disallow expenses that are not incidental to producing income,
according to the bill that preceded the amendment.
The disallowance of "home expenses" is not new, but until now
it has been acceptable for business people who work entirely from home
to treat one room as an office. Will it continue to be possible to
deduct a relevant portion of rent, water, city taxes and electricity
expenses - e.g. 25% if one room out of four at home is used as the
office? Presumably, it will become important to show that the office
room does not get used for private domestic purposes as well. Lock it
up at night and ban the kids from entering?
Extra tax credit
Second, after taking away an expense deduction for
child-minding, the amendment grants an extra tax-credit point for each
child starting in the tax year after birth and ending in the tax year
the child reaches five years old, but this only begins in 2012. A
tax-credit point currently reduces tax due by NIS 197 per month; it is
updated periodically for inflation. If the wife works, she will usually
receive this tax credit; if she doesn't, normally the husband will in a
joint tax calculation (exceptions exist).
So suppose a full-day kindergarten costs NIS 2,500 per month.
Under the new law, a working parent will save tax of NIS 197 per month
for up to five years starting in 2012, irrespective of the level of
income. This figure will be updated for inflation.
By contrast, the Vered Perry case would have allowed an expense
deduction of up to NIS 1,666 (two-thirds of NIS 2,500). So if a couple
each earn NIS 8,000 per month, they would deduct NIS 1,666 from income
and save marginal tax of 15%, resulting in a tax saving of NIS 250. If
the couple each earn NIS 20,000 per month, they would save marginal tax
of 34%, resulting in a tax saving of NIS 566 apparently. And if the
couple each earn NIS 40,000 per month or more, they would save marginal
tax of 46%, resulting in a tax saving of NIS 766 apparently. The
savings would be even greater if national insurance is factored in. But
as mentioned, the Vered Perry case was negated by the amendment.
What happens in other countries?
In the US a child-care tax credit is available of 20%-35% of
qualifying expenses of up to $3,000 per year for one qualifying person,
or $6,000 for two qualifying persons (See IRS publication 503). Note
that 20% of $3,000 per year = $600 per year = $50 per month, which is
about the same as the upcoming NIS 197 credit per year in Israel
In the UK there is a complex Child Tax Credit and Working Tax
Credit to help support families with children and working people on low
incomes; the child-care element can help with up to 80% of eligible
child-care costs up to a maximum of £175 a week for one child, £200 for
two or more children (See HM Revenue & Customs Leaflet WTC5). The
UK system of tax credits is considered a bureaucratic nightmare. It is
basically a state benefit, but is now run by the taxing authority,
HMRC. The amount of tax credits you get depends on things like: how
many children you have living with you; whether you work and how many
hours you work; if you pay for child-care; if you or any child living
with you has a disability; if you're aged 50-plus and are coming off
benefits; your income (the lower your income, the more tax credit you
up, a flat-tax saving in Israel
of NIS 197 per child per month up to
age five from 2012 is better than nothing. And to up the stakes, the
writer of this column will buy lunch for the first reader who
successfully invokes the Vered Perry case to claim a similar child-care
expense deduction in the UK or any other country that has adopted UK
As always, consult experienced tax advisers in each country at an early stage in specific cases.
Leon Harris is an international tax advisor based in Israel. Stuart Harris is a Chartered Certified Accountant based in London.