Haven’t Come Clean Over Undeclared Assets? Watch Out

Israel Tax Authority expects value of assets disclosed under new disclosure program to result in additional tax revenue of at least 1 billion shekels.

Eyal Toueg

It took a full year for the Israel Tax Authority to draw up the new regulations for voluntary disclosure of income and assets before they took effect in September, allowing taxpayers to own up to previously unreported revenue and holdings in exchange for immunity from criminal prosecution. The goal was to learn the lessons from the previous disclosure program, which was in effect from November 2011 through September 2012, under which 1,400 Israelis disclosed a total of 12 billion shekels ($3 billion) in assets from 1,400 taxpayers and paid around half a billion shekels in back taxes.

But how successful is the new disclosure program, which tax authority director Moshe Asher lauded highly during its launch? Asher traveled to Switzerland in order to encourage the banks there to read the riot act to their Israeli customers on the need to report their foreign assets to the Israeli tax agency.

In the six months since the new disclosure program went into effect, 1,240 declarations were submitted, the tax authority says. Of these, 768 were filed anonymously, 252 requests through a fast-track process and 220 through the “regular” channel. The value of disclosed assets totaled 4.1 billion shekels, about a third of the amount that was reported during the 10 months of the previous program. The anonymous and abbreviated tracks were implemented as temporary “emergency orders” for just one year, through September 2015, although they might be extended past that date.

Nonetheless, it is still difficult to reach any conclusions yet. Yaakov Karta is a lawyer and certified public accountant who was a professional consultant to Asher until five months ago. He coordinated the drafting of the procedures in 2012 and played a major role in organizing the agency’s implementation of the latest program. Karta says that past experience indicates that the bulk of the declarations of assets are submitted in the final month before the deadline, suggesting that the floodgates will open in August.

Karta says the increase in tax payments under the 2011-12 disclosure round was due to a number of “heavy” cases, adding that the average of filers was 75 and older and the average value of each reporter’s assets was around $500,000.

To a certain extent, the new regulations were a relatively weak starting point, since this new program is more “expensive” for the taxpayer than the previous one, which granted tax breaks, a full exemption from fines and interest and a substantial discount on linkage to inflation. Karta says that it was the State Prosecutor’s Office, which was a partner in approving the new regulations, that insisted on the new terms, since the decision on providing full criminal immunity was in its hands. The Prosecutor’s Office wanted taxpayers to pay their taxes in full, at current values, in return for full immunity from prosecution. But the tax assessors are authorized to cancel fines, Karta notes.

Meanwhile, tax authority officials say the new program is a success. They expect the value of assets disclosed under the new program to be at least double that of the previous regime, resulting in additional tax revenue of at least 1 billion shekels.

‘I recommend the regular track’

There are a number of differences between the present regulations and the previous disclosure program, including the computerization of the process along with the introduction of systems that allow the tax authority to monitor progress on disclosure declarations and their results.

In addition, the 2012 procedures applied only to passive income held overseas, while the new program is for all unreported income and assets, including not only overseas bank accounts, inherited assets held abroad and income from foreign rental property but also previously unreported income that was earned within Israel.

Another innovation is the fast track, which allows filers to disclose relatively small amounts and pay taxes owed without having to negotiate with a tax assessor. The new rules also continue with the anonymous track, which was in force from July through September 2012 and which accounted for more than half of the disclosure declarations.

In the anonymous track, the taxpayer applies for a ruling through a lawyer or accountant without revealing his or her identity, and in turn receives an assessment from the tax authority. Karta says the vast majority of those who file an anonymous request for assessment follow through on the process and identify themselves after finding out how much they owe. In the previous program, fewer than 70 of the 700 people who filed anonymously, or under 10%, withdrew from the program after finding out how much they owed, and in some cases it was because they could not provide the necessary documentation, he said. It is reasonable to assume that those who start the disclosure process are already psychologically prepared for the results, and even those who are not pleased with their tax bill often feel they have come so far that there is no reason to back out now.

“I would recommend people apply through the regular track, which is faster, and not the anonymous process,” says Karta. The handling of the anonymous track takes longer — up to 180 days — and during this period there is a possibility that the tax authority will initiate an audit or send a letter demanding they disclosure their income and assets. Once such a demand is set, the taxpayer is blocked from the voluntary disclosure program.

The great majority of those who start the process complete it, so in any case for most people there is little reason to use the anonymous track, Karta says.

‘Leaving the Tax Authority because of the salary’

The biggest problem today in the Israel Tax Authority is a shortage of professional staff, says Karta. Even when they recruit new employees, they usually avoid mentioning the numbers leaving. “Good and professional people leave because of the salaries,” says Karta. “The moment a senior inspector with five years of experience who earns 8,000 to 9,000 shekels net [a month] reaches a reasonable salary level of 15,000 shekels [a month] after taxes, not that many employees will leave for the private sector. These are simple considerations of cost versus benefit.” Karta himself left the civil service and opened his own tax consulting office after leaving the tax authority late five last year.

As to the controversial issue of requiring universal reporting in Israel, Karta says there are already 2.5 million salaried employees in Israel who pay their income taxes directly through salary withholding, so why expand this? He says research has found that it is not worth the effort. The banks also withhold taxes at the source on all capital gains, most companies and self-employed individuals pay estimated taxes in advance and there are mechanisms for withholding by suppliers and contractors, so most income tax is collected automatically, he says.

22,000 new taxpayers filing returns

If the new program still has not fulfilled its potential, then the letters sent in May through July of 2014 to some 100,000 citizens have already led to the opening of 13,300 new tax files. The tax agency is now sending out reminder letters to the 50,000 or so individuals who did not respond. Tax officials says the reminders have increased the pace of new filings.

The goal is to widen the base of those who file income tax returns and report their income and assets, and not necessarily to collect much more in taxes. “The goal is to reach 22,000 new filings,” said Karta.

Red flags

The tax authority has not said who received the letters to, but Karta describes some of the situations or activities that are like red flags to the agency, potentially prompting demands for disclosure. These include traveling abroad five or more times a year, owning three of more homes between 2007 and 2013 — Karta says this triggered more than half of the 100,000 letters sent — buying luxury assets such as a vehicle costing over 500,000 shekels, requesting three or more income-tax withholding adjustments (“tium mas”) in recent years and earning an annual salary of more than 600,000 shekels. In addition, Karta says, a merchant who purchases vehicles through an agent and who does not who not file annual tax returns may also incur a demand for the disclosure of income and assets.

Because the recipients of the letters were selected by an algorithm, there were some surprising, even hilarious results, such as demands for the disclosure of assets being sent to children, to individuals who comply with the reporting requirements and even to a few employees of the Israel Tax Authority, who were asked to report their income.

In cases where the disclosure demand appears unwarranted, it can be appealed. At this stage, the tax agency is trying to expand its list of “red flags,” for example to the purchasers of certain luxury goods.

Karta thinks there are benefits to the tactic of sending out the letters, even though their recipients are barred from the voluntary disclosure program.

“In certain cases it is preferable to receive the letter and open a file, and not to take voluntary disclosure,” says Karta. The disclosure proceedings can take many months and cost thousands of dollars in fees for lawyers, accountants and tax advisors. Responding to a demand letter can be cheaper and faster. The respondents might not receive immunity from criminal prosecution, but the voluntary disclosure process has its own hazards, for example to someone who is retroactively reporting income from rental property.

The best solution in such cases is to file amended tax returns, since this is a more common procedure, and every voluntary disclosure case is “examined under a magnifying glass,” Karta says. In addition, in the case of amended returns, the tax authority can only legally go back four years, while in the voluntary disclosure process the limit is 10 years. The fines can also be higher in such cases, and even though there may be no criminal sanctions, these are also very unlikely if the taxpayer reports all their pat income by filing amended returns.