Bank Leumi Seeking Unprecedented Tax Breaks in Light of U.S. Penalties

Petition yet to get approval from Israel Tax Authority or courts.

Bloomberg

Bank Leumi will be seeking an unprecedented tax break by asking the government to recognize the cost of the $400 million in penalties it paid to U.S. and New York state authorities for helping clients to evade U.S. income taxes.

Leumi’s petition, which would reduce the bank’s tax liability for 2014 by between 250 million shekels and 300 million shekels ($63.6 million to $76.3 million), has yet to get approval from either the Israel Tax Authority or the courts. But attorneys who spoke with TheMarker said the bank had a good legal case.

Leumi, Israel’s second-biggest lender, reached a settlement with U.S. authorities in December to pay the fine and also incurred 250 million shekels in legal and accounting expenses related to the case.

On the one hand, for Israel’s tax authorities to recognize the costs as tax-deductible expenses would in effect mean the government is subsidizing a penalty levied on the bank by the United States for egregious violations of its tax laws.

On the other hand, without recognition of these expenses the bank would be subject to an especially high effective tax rate, because it will be paying tax on profits it didn’t earn. Israeli banks pay an effective tax rate of 37.71% of profits.

Of the total costs, 40% was covered by Leumi itself while the other 60% was split evenly between its Swiss unit and its U.S. unit, both of which were directly involved in the tax-evasion scheme. But as part of the settlement signed in December, Leumi agreed not to seek tax recognition from the U.S. for the penalties, which means the 30% of the costs falling on Leumi U.S. are lost.

The Swiss government already has experience with this problem because Credit Suisse last year sought to deduct one-third of a $2.6 billion penalty it agreed to pay in a related U.S. tax investigation.

Critics, particular in the Swiss Social Democratic Party, protested that it would mean that Swiss taxpayers would be helping Credit Suisse to meet its legal obligations.

In September, the Swiss cabinet decided that criminal fines imposed on companies could not be tax-deductible, although it did agrees that tax rebates could be claimed on illegally gained profits a court has ordered a company such as Credit Suisse to repay.

In Israel, Moshe Mizrahi, who until 2011 was legal adviser to the Tax Authority and today is a partner in the Moshe Mizrahi, Noach, Kriegel Law Office, said penalties paid to U.S. authorities were a legitimate revenue-producing expense that should be recognized for tax purposes. He said he expected the courts would rule on it quickly and without much controversy.

“If the investigations had continued and even led to criminal sanctions, the bank might have lost its U.S. license. The [bank] decided to pay a very big sum to close the case in order to continue its business and make profits,” explained Mizrahi.

“I have no doubt that meets the test of allowable expenditures under the Income Tax Ordinance, which says any expenses used to keep a company in business are considered revenue-generating expenses,” he said.

The question of whether that serves the broader public interest is more difficult to answer. The bank has not been accused of violating any law in Israel, although the attorney general has set up a committee to examine whether Leumi did engage in any violations under Israeli law.

Tali Yaron-Eldar, a former income tax commissioner and a partner in Yaron-Eldar, Paller, Schwartz & Company, said she was less sure because the court have ruled over the years that deducting expense for tax purposes must not violate the public’s interest. She said the tax authorities might agree to recognize some elements of the penalties for tax purposes and reject others much along the same principle as Swiss authorities did.

“For the type of settlement signed by Leumi there’s no legal precedent. If the payment is a substitute for a punishment, I suppose the Tax Authority would not allow it as an expense. But if it is civil penalty, then it is not against the public’s interest,” she said.