The general rule regarding expenses is that theyare deductible for Israeli tax purposes if the expenses are incurredwholly and exclusively in the production of taxable income (Income TaxOrdinance Section 170).
Thismay sound familiar to British and British Commonwealth readers, as itwas inherited from UK tax law thanks to British mandatory rule in1917-1948. More recently, an Israeli lawyer, Vered Perry, scored amajor victory in the Israeli Supreme Court, which ruled that herchild-minding expenses were deductible, as they were incurred in theproduction 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 wasdeductible but not education or meals, as they benefit the child, notthe mother. Therefore, for simplicity in such a mixed case, the SupremeCourt 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 thefather and the mother.
However, the Perry case caused consternation in theFinance Ministry: everyone with children would start claiming similardeductions going forward and also going back as far as the statute oflimitations allows (generally three years after the end of the year inwhich a tax return is filed). The result would have been billions ofshekels in tax refunds now and reduced tax receipts in the future.Nature intended us to have children and a big tax refund would add tothe pleasure.
This result would have wreaked havoc on the government'sfinances, but not any more. On July 13, 2009, the Knesset passedAmendment 170 to the Income Tax Ordinance, and it was published atlightning speed on July 16, 2009 (Book of Laws 2202). The amendment hastwo main parts.
Expense deduction negated
First, the amendment negates the Vered Perry case decision byclarifying what is NOT deductible, namely: "Expenses that are notexpenses connected and integral to the process of producing income -including home expenses, private expenses, private expenses, expensesincurred in reaching the place of work and back again, and expensesincurred on the 'treatment or minding' of a child or other person.""Treatment" apparently refers to the kindergarten experience thatIsraeli infants thrive on.
"Expenses connected and integral to the process of producingincome" are tightly defined as "expenses integral to the naturalprocess of producing income and the natural make-up of the source ofincome, and representing an inseparable part thereof." The aim is todisallow 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 nowit has been acceptable for business people who work entirely from hometo treat one room as an office. Will it continue to be possible todeduct a relevant portion of rent, water, city taxes and electricityexpenses - e.g. 25% if one room out of four at home is used as theoffice? Presumably, it will become important to show that the officeroom does not get used for private domestic purposes as well. Lock itup at night and ban the kids from entering?
Extra tax credit
Second, after taking away an expense deduction forchild-minding, the amendment grants an extra tax-credit point for eachchild starting in the tax year after birth and ending in the tax yearthe child reaches five years old, but this only begins in 2012. Atax-credit point currently reduces tax due by NIS 197 per month; it isupdated periodically for inflation. If the wife works, she will usuallyreceive this tax credit; if she doesn't, normally the husband will in ajoint 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 monthfor up to five years starting in 2012, irrespective of the level ofincome. This figure will be updated for inflation.
By contrast, the Vered Perry case would have allowed an expensededuction of up to NIS 1,666 (two-thirds of NIS 2,500). So if a coupleeach earn NIS 8,000 per month, they would deduct NIS 1,666 from incomeand save marginal tax of 15%, resulting in a tax saving of NIS 250. Ifthe couple each earn NIS 20,000 per month, they would save marginal taxof 34%, resulting in a tax saving of NIS 566 apparently. And if thecouple each earn NIS 40,000 per month or more, they would save marginaltax of 46%, resulting in a tax saving of NIS 766 apparently. Thesavings would be even greater if national insurance is factored in. Butas 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% ofqualifying expenses of up to $3,000 per year for one qualifying person,or $6,000 for two qualifying persons (See IRS publication 503). Notethat 20% of $3,000 per year = $600 per year = $50 per month, which isabout the same as the upcoming NIS 197 credit per year in Israel.
In the UK there is a complex Child Tax Credit and Working TaxCredit to help support families with children and working people on lowincomes; the child-care element can help with up to 80% of eligiblechild-care costs up to a maximum of £175 a week for one child, £200 fortwo or more children (See HM Revenue & Customs Leaflet WTC5). TheUK system of tax credits is considered a bureaucratic nightmare. It isbasically a state benefit, but is now run by the taxing authority,HMRC. The amount of tax credits you get depends on things like: howmany children you have living with you; whether you work and how manyhours you work; if you pay for child-care; if you or any child livingwith you has a disability; if you're aged 50-plus and are coming offbenefits; your income (the lower your income, the more tax credit youcan get).
To sumup, a flat-tax saving in Israel of NIS 197 per child per month up toage five from 2012 is better than nothing. And to up the stakes, thewriter of this column will buy lunch for the first reader whosuccessfully invokes the Vered Perry case to claim a similar child-careexpense deduction in the UK or any other country that has adopted UKprinciples.
As always, consult experienced tax advisers in each country at an early stage in specific cases.