Closing the Courts to Tax Evaders

The pressure on the government to find new sources ofincome to cover the huge deficits anticipated in the 2013 and 2014 budgets yielded its first fruits this week with the release of recommendations by a committee headed by Israel Tax Authority director general Doron Arbely. Armed with an extensive plan to wage war on Israel's black market, Arbely laid out how the state can bring in an additional NIS 6 billion in tax revenue, NIS 2 billion in 2013 alone.

But Arbely's battle cry that paying taxes honestly is the ultimate act of social justice – "Everyone equal, not only in enjoying public services but also in carrying the tax burden" – has not caught on outside the government. It has become clear that the courts – even the Supreme Court – feel differently.

Last July, Supreme Court President Asher Grunis rejected an appeal by the state against a previous Supreme Court ruling by a panel consisting of justices Esther Hayut, Miriam Naor and Isaac Amit. Grunis agreed with his colleagues on the bench that the state owed the petitioner, Herzl Raphael Klif, NIS 6.3 million in additional compensation for evacuating a factory he owned on the border of the Gaza Strip.

Klif, as it turned out, had provided the state with inaccurate reports about his factory in the Erez industrial zone. "There is no dispute that the company spent millions of shekels more on the building's construction than the expenses reported by the company to the tax authorities over the years," wrote Grunis in his decision.

Nothing would probably have come of the misreporting if it had not been for the evacuation of Gaza, when the state tried to compensate Klif for only his reported expenses and not for those he had failed to report. Shockingly, the government had the audacity to think it could refuse to pay for expenses Klif had not reported and deprive him of the just rewards for his oversight.

But Klif appealed the government's decision and the issue reached the Supreme Court. Hayut ruled that Klif's personal circumstances must be taken into account; namely his explanation that the funds he did not report came from his own pocket rather than the company's coffers. Grunis agreed on this point, citing the principle in civil law that: "The injured party cannot be denied the opportunity to claim that his income was higher than the amount reported to the tax authorities."

In his decision, Grunis also quoted the government's desperate plea for him to overrule Hayut's ruling, which said, "The verdict could legitimize funds deriving from tax evasion and perhaps even money laundering by obligating the state to compensate the investment of these same funds. Proper legal policy considerations require sending out a loud and clear normative message that someone reporting partially or falsely to the authorities will not, in future claims against the state, stand to be rewarded from its coffers and to legitimize this by betraying his own reports."

The government even noted that the verdict could have severe budgetary implications if other evacuees from Gaza demand that incomplete income tax reporting be accepted in calculating the compensation they are entitled to. The government estimated such claims could amount to hundreds of millions of shekels.

But the threat of huge additional expenses – like the argument for making a statement against incomplete reporting to tax authorities – did not convince the justices. In rejecting the state's appeal, Grunis ordered it to pay Klif NIS 6.3 million in additional compensation, even though no one disputes that Klif did not report the relevant investments to the tax authorities in a timely way.

Grunis' ruling, which fumbles away much of the normative basis for the state requiring its citizens to pay taxes honestly, was picked up by the Arbely committee. The committee discussed changing the law – once and for all plugging the legal loophole that allows courts to award compensation to people who file incomplete reports with the tax authority – but ultimately got cold feet and decided not to cross the High Court.

Instead, it came up with a recommendation for a much tamer law. If the court awards compensation for a transaction that was not reported to the tax authorities, the insurance company paying the damages will be required to withhold the unpaid tax and transfer the amount to the tax authority. This way the state can, at least retroactively, collect the missing tax.

This is a deal almost any thief would happily agree to. If caught, the only punishment is returning the stolen loot. It provides no real deterrence against future tax evasion.

The Arbely committee, though, hopes another of its recommendations will provide greater deterrence. If it were made law, any admission of tax evasion by a claimant in court would be relayed to the tax authority.

"We'll be able to do whatever we want with this information," said a Tax Authority official, implying that criminal proceedings could be initiated against such a tax evader. "There is an admission in court on performing a tax offense, which has serious implications."

The Tax Authority thinks the threat of having tax evasion reported to it would dissuade anyone from claiming damages for property acquired "under the table." But the recommendation raises two issues. First, it is not clear to what extent an admission in a civil case can serve as evidence in criminal proceedings. And second, the government's policy of acting against anyone who admits inaccurate tax filings in court was not evident in the case against Klif. As far as is known, the Tax Authority did not take any action against him. It is, though, promising to take a much firmer stance in the future.