Your Taxes: Don’t Throw Away Your Foreign Tax Credit

Your Taxes: Don’t Throw Away Your Foreign Tax Credit

The Israeli Supreme Court has just ruled that a taxpayer cannot claim a foreign tax credit under the US-Israel tax treaty (Tel-Aviv 4 Assessing Officer vs. Gmul America Ltd, Civil Appeal 8934/16 of June 11, 2018).

Double taxation and no tax treaty relief is not good for international trade and investment by Israelis.

So what went wrong?

Quite a lot, it seems. In fact, the Supreme Court judgment is a curt two pages, and we have to go back to the earlier District Court case to discover what upset the judges and the Israeli Tax Authority (ITA) so much.

The Facts:

The taxpayer, an Israeli company (G Ltd) , held US real estate via five US LLCs (Limited Liability Companies) and sold the LLCs in 2006 at a profit of around NIS 53 million on which the Israeli tax was 25% or around NIS 13 million. The taxpayer claimed a credit for US taxes on the deal, which were largely refused by the ITA.

What went wrong?

First, NIS 17 million of US taxes were indeed paid in 2006-2008 but later refunded in the US as tax losses in later years were carried back and utilized in the US. The taxpayer tried to invoke Article 26(3) of the Israel-US tax treaty which allows US tax “paid or accrued” to be credited.  The District Court rejected this and called it “a creative interpretation…that leads to absurdity”. The Supreme Court was more reserved and pointed out that the Treaty credit is granted in principle but is subject to Israeli tax law which only allows a credit for foreign taxes actually paid.

Second, the taxpayer claimed a credit for US taxes of around NIS 7 million of US taxes regarding 2009. The ITA rejected this as being out of time.  This is because Section 207B of the Income Tax Ordinance (ITO) permits a credit for foreign tax paid within 24 months after the tax year in which Israeli tax arises.

The District Court tried to help by letting the taxpayer claim there was a change in Israeli or foreign taxes resulting in another two years to claim the foreign tax credit (ITO Section 210. The ITA appealed and the Supreme Court accepted the appeal, upholding the Section 207B two year time limit.

Third, the District Court noted the taxpayer apparently could have claimed a foreign tax credit regarding by making the LLCs fiscally transparent according to ITA Circular 5/2004. Unfortunately, the taxpayer “chose not to act” according to it…..

To sum up, double tax all counts for the taxpayer. For World Cup soccer fans, the ITA beat the taxpayer 3-0.

Lessons to Be Learned:

Double tax is painful especially if it could have been avoided. The lessons to be learned here are:

  •    Always check out the tax situation in all countries in advance;
  •    Always plan foreign tax credits especially carefully;
  •    Tax Circular 5/2004 dealing with Israeli tax transparency for LLC’s must be elected in the first relevant annual tax return, not years later;
  •    Tax planning is okay when it comes to claiming what the tax law and tax treaties expressly allow – but watch out for time limits.
  •     In short, don’t count on the Israeli court system to bail you out if you mess up your tax planning.

Last but not least, crediting foreign tax paid but later refunded is now a “reportable position” – it must be reported to the ITA within 60 days after filing the main annual income tax return. That means the ITA is likely to open up a tax audit…

What Should You Do?

Before entering into any international investment or activity, check there will be no tax surprises. That includes checking which taxes arise, when, and whether a foreign tax credit or other relief is available. Don’t stop at income tax.

Also check out other taxes such as VAT or sales tax, stamp duty, employee taxes and social security and so forth.

And read tax treaties carefully in the light of domestic legislation and the new OECD multilateral instrument which is about to amend many tax treaties.

Making money is good, making the most of the after-tax portion is better.

Next Step:

Please consult us before embarking on any international venture.

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

The writer is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd

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July 11, 2018

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