20.04.2010

Israel goes into its 63rd year with discerning tax and judicial systems.

While we celebrate Yom Ha‘atzmaut, let‘s review a dramatic court drama that recently unfolded here. It has all the ingredients of a crime thriller, a tough legal issue, and state tax revenues at stake.

The taxpayer, a dashing lawyer by profession, was tried for killing someone and wounding two others. According to the indictment, someone called the lawyer and asked for professional advice about a family law matter and arranged to meet him at night at Kfar Devoriah.

SELF-DEFENSE

The lawyer arrived at the meeting place and was surprised to find he had walked into an ambush; three people were waiting for him with wooden clubs. When he arrived, they started beating him up. Fortunately, this lawyer carried a gun. In the heat of the fight, he pulled out the gun, aimed at his three assailants, killed one of them and wounded the other two. In the end, the court found the lawyer was innocent on grounds of self-defense.

But it didn‘t end there. In his VAT returns, the lawyer claimed back the VAT on his legal expenses. The VAT Division turned this down. The lawyer appealed. At first the appeal was rejected, but later the VAT Division recognized half the legal expenses as being business inputs.

That wasn‘t good enough for the lawyer; he appealed to the Nazareth District Court (Sami Shibli vs the VAT Division, Ayin Shin 000002/10 of April 8, 2010). The judge was Avraham Avraham.

Section 38 of the VAT Law states that a business dealer is entitled to offset input VAT according to a lawfully issued tax invoice against the output VAT it owes the VAT Division. Section 1 of the VAT Law states that VAT is imposed on services rendered to a business dealer for the purposes of, or for use in, a business.

The lawyer claimed the legal expenses in his trial were incurred either: (1) to enable him to continue practicing law, or (2) in the course of his business.

THE RULING

If you were judging the case, what would you rule?

Regarding the first claim (trial expenses incurred these expenses) the Court ruled these were just like medical expenses, which are not recognized for tax purposes. Expenses incurred in a criminal trial to preserve the liberty of a business dealer, his good name, his health, his life and so forth, are located beyond the boundary between what can be claimed and what cannot, even though each of these fundamental things are necessary to enable a business to keep going.

Regarding the second claim (trial expenses incurred in the course of the individual‘s business), the judge stated: ‘‘This case is far beyond the boundary of what can be recognized. I do not think that a business dealer who defends himself against a client who comes to attack him and kills him as an act of self-defense does so for the purposes of, or for use in, a business. He does so to defend his body, not his business. It is not an act in the ordinary course of his business.‘‘

In other words, the taxpayer should count his blessings he wasn‘t convicted and that justice prevailed. But the criminal-trial expenses could not be recognized for VAT purposes.

The case dealt with VAT, not income tax. For income-tax purposes, an expense is generally deductible if it is incurred wholly and exclusively in the production of taxable income. Presumably, such trial expenses may not be recognized for income-tax purposes for the reasons outlined above.

Israel goes into its 63rd year with discerning tax and judicial systems.

As always, consult experienced tax advisors in each country at an early stage in specific cases.

leon.hcat@gmail.com

Leon Harris is an international tax specialist at Harris Consulting & Tax Ltd.