Your Taxes: Illegal payments: Can bribes be a deductible expense?

Israeli tax law lets taxpayers deduct expenses if they were incurred wholly and exclusively in the production of taxable income.

taxes good 88 (photo credit: )
taxes good 88
(photo credit: )
Lately, we have witnessed strange events in the mother of parliaments: British members of Parliament returning excessive expense reimbursements and cabinet ministers resigning. In the US, a governor recently resigned, and the expense claims of congressmen may even be posted on the Internet. What about Israel: Are we any different? It seems we are now minus one prime minister after various expense and other allegations were reported by the Ombudsman's Office; the outcome remains to be seen. And a former director of the Israel Tax Authority resigned and reportedly faces inquiries over personal benefits allegedly received, together with other senior tax officials among others, apparently. Israel passed Amendment 99 to the Penal Law, 1977, to expressly outlaw the giving of bribes to a foreign public employee in connection with business activity, commencing July 21, 2008. For Israeli tax purposes, there is no question that unlawful income received is still taxable, but what about unlawful payments made? Are they a deductible expense? In general, Israeli tax law lets taxpayers deduct expenses if they were incurred wholly and exclusively in the production of taxable income (ITO Section 17). Payment of bribes An anonymous District Court case judgement issued in January 2008 was elusively known as "Company Ltd. and Individual vs Netanya Assessing Officer" (Tax Appeal 001015/03). In this case a company contacted a foreign government of an unnamed country regarding the possibility of developing an agricultural venture. To clinch the deal with the relevant parties in the country concerned, the company claimed it was necessary to pay "brokerage commissions" to various persons in 1998 at all levels in all the bodies concerned directly or indirectly in the deal, according to local custom in that country. The court stated that recognition of bribe payments, even if they are paid abroad, would contravene the principles of freedom and equality. Such recognition would contradict the commitment of the State of Israel in its Declaration of Independence to be faithful to the United Nations Charter. The court stated that recognizing bribes as an expense would turn the Israeli public, which pays taxes, into accomplices of such deeds. Double illegality Later in 2008, the Supreme Court ruled in the case of Hydrola Ltd vs Assessing Officer Tel-Aviv 1 (Civil Appeal 6726/09). In this case, the taxpayer company carried out various business activities, including the sale of medical equipment and food products, in the republics of the former Soviet Union. The company conducted its business via agreements with local agents. It transferred to them large sums of money that were used to pay the agents and for other purposes, including remittances to local parties to promote the success of the deals. According to the Supreme Court, the payments made by the company's agents abroad were illegal payments for tax deduction purposes, since they were not legal in the country where they were spent, or so it is presumed absent any evidence to the contrary from the company. Also, the payments are not legal in the taxing country, Israel. In other words, they amount to "double illegality," with the weight of the term "double criminality" used in extradition laws. The Supreme Court ruled that allowing such payments as deductible expenses would be contrary to public order. The fact that the illegal act was performed outside Israel does not detract from this principle. Nevertheless, the Supreme Court did allow part of the payments attributable to remuneration of the agents, despite the lack of detailed records, based on the testimony of the agents. No tax deductions While the end justified the means, these were convoluted court cases. To clarify matters, Proposed Amendment 170 to the Income Tax Ordinance was published on June 1, 2009. This proposes the following: When ascertaining the taxable income of a person, no deductions shall be allowed for payments made with money or kind if reasonable grounds exist to assume that giving them represents an offense under any law. The explanatory notes to the bill cite the intention to enact the Tax Authority's position in the Hydrola Case. This proposed amendment fits in with the requirements of the Organization for Economic Cooperation and Development (OECD), which invited Israel to start the process of joining in May 2007. This process is still in progress. On December 9, 2008, Israel became a member of the OECD Working Group on Bribery. On March 11, 2009, Israel became the 38th signatory to the OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions. This convention outlaws bribery of foreign public officials in international business transactions. According to the OECD, Israel's accession to the convention represents an important commitment to the international fight against corruption. Furthermore, the Israeli government ratified joining the UN Convention Against Corruption in December 2008. As always, consult experienced tax advisers in each country at an early stage in specific cases. Leon Harris is an international tax specialist.