You may have noticed recent press reports about a victory for the taxpayer regarding child-minding expenses. Most Israeli kids are placed with kindergartens in the daytime and child-minders in the late afternoon and perhaps evening. All this starts from a very early age - often only a few months old - so the parents can go to work and the kids can start mixing with other kids and learn basic things. Until now, the cost of child-minding was assumed to be a private non-deductible expense for Israeli tax purposes. The cost can be quite high for working families. The Tel Aviv District Court issued a surprise judgement regarding child-minding expenses (Vered Pery vs Gush Dan assessing Officer, Tax Appeal 001213/04, April 3, 2008). In this case, the taxpayer was a lawyer with her own practice and a mother of two children who sought to deduct child-care expenses. She claimed the expenses were not private in nature, but purely business-related and did not result in any personal benefit. The assessing officer rejected the expense deduction. The court made a number of interesting observations, as summarized below. A baby or a child in a day care center is there not because he benefits from it, but because his parents cannot earn a living if they have to look after him during those hours. It was not disputed that the care is essential and without it the taxpayer cannot earn income. Nevertheless, there is a personal element within the expense that benefits the child and its parents, which is secondary to the main reason for the child going to the kindergarten or care center or child-minder. Assuming the expense is essential to the production of income, it is necessary to consider whether the expense satisfies the deductibility criteria of Section 17 of the Income Tax Ordinance, which requires expenses to be incurred wholly and exclusively in the production of income. The word "exclusively" in the law means the expense must be purely business. What does "purely business" mean? The court said that in this computerized and documented age, in which any activity can be tracked and reconstructed, if the mother can prove convincingly that the requirements of Section 17 are met - an expense is incurred in the production of income - after quantifying it and after stripping out the part that is not incurred in the production of income, a deduction may be allowed. In this regard, a review of an orderly budget and records and analysis of the various expenses may help, or other models may be used. The court distinguished between the personal benefit from educating ("enriching") the child and the business benefit of looking after the child. The court said it was reasonable to assume that the cost of the education/enrichment benefit is low, relative to the child-cost of looking after the child, minding costs that are the main expenses. Even if the split changes over the years as the child grows up, it is still reasonable to assume that the main costs of the kindergarten, care center or child-minder are minding expenses that are deductible. Fortunately, working parents need not track their child-minding expenses on a laptop. The court went on to develop a practical approach, and ruled that the taxpayer may deduct for tax purposes two-thirds of the amounts spent on looking after the children in facilities that did not provide food (other than light refreshments) or that charged separately for food; and half the amounts spent on facilities where the amounts included food for the children (this was pursuant to authority under Section 156 of the Income Tax Ordinance and Section 11 of the Court Regulations (Income Tax Appeals)). As for summer camps for children, the court said additional consideration was needed, but remarked that, in general, their activity was closer to personal education/enrichment. The Israel Tax Authority quickly indicated its dissatisfaction with the judgement. It may well reduce tax revenues by billions of shekels, since taxpayers may be able to deduct such expenses not only in the 2008 tax year but also in past open tax years. Moreover, working mothers receive a special but limited personal tax credit. Consequently, the Tax Authority seems set to appeal the judgement and/or initiate a legislative amendment to nullify the judgement. How can you claim your child-minding expense deduction? If you are a self-employed freelancer, you might add an expense to your income statement attached to your tax return. If you are a salaried employee or not working, you would need to file an annual personal tax return and claim the expense - but you won't find a specific line for this on the tax return form. You should make reasonable disclosure of your position. Since the Tax Authority probably has a different position, don't expect it to be plain sailing. As always, consult experienced tax advisors in each country at an early stage in specific cases. [email protected] Leon Harris is an international tax partner at Ernst & Young Israel.