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). This 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 Israeli 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 the pleasure. This result would have wreaked havoc on the government's finances, but not any more. On July 13, 2009, the Knesset passed 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 Â£175 a week for one child, Â£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 can get). To sum 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 principles. As always, consult experienced tax advisers in each country at an early stage in specific cases. firstname.lastname@example.org email@example.com Leon Harris is an international tax advisor based in Israel. Stuart Harris is a Chartered Certified Accountant based in London.