Category Archives: Article

YEtax Partner Rany Schwartz talks VAT Taxation

Duns100 Interviews Partner Rany Schwartz on VAT Taxation issues. The below is a translated transcription of the original online Hebrew publication 2.08.22

Listen to the podcast (in Hebrew) here

 

Problems involving taxes can be an expensive matter. What can cause these kinds of issues?

No one likes being audited. Even if you’re certain you’ve operated entirely above board, when someone actively looks for issues they’re likely to find them. Sometimes these are just small deviations, but often we’ll discover that we’ve been operating long-term in a way that, in hindsight, turned out to be problematic. Whether this is the result of poor advice or just an innocent mistake, it’s liable to cost us a lot of money – this is essentially an opportunity for the tax authorities to collect money that belongs to the State.

How does the VAT system work?

I collect value added tax (VAT) for the State, hold it, and then transfer it to the tax authorities. After that, any retroactive claims by the authorities can result in a considerable deficit on my part, since I’ve already spent that money.

Our experience allows us to identify the major flaw in this method: you can’t truly know who you’re doing business with. Generally, we don’t have the ability to do comprehensive due diligence, which that means we need to be very cautious. For example, if I work with a vendor and know they are in financial straits, what’s most important to me is understanding that if I pay them for services rendered, I must be certain they transfer that VAT.

Even after I’ve already paid the VAT to them?

That’s exactly the point, it’s input VAT! I paid VAT to the vendor out of my own pocket in order to receive a service, and in turn they must pass that VAT on to the tax authorities. If they haven’t done so, I am expected to pay an indemnity to the State. While it is possible to defend against these charges in some cases, it isn’t in others. It depends whether I made a point of looking into the client or vendor beforehand – whether or not they are a registered business, who is receiving the service. Invoices must be issued only to the service recipient, not the payer. Otherwise, the tax authorities can label them fictitious invoices. This term has lost a lot of its meaning!

What else can create VAT problems?

Here’s another common example: it may turn out, after the fact, that an invoice issued for services provided lists the details of a licensed dealer that are not those of the vendor itself.

Why does this happen?

It may be that the vendor wants to provide a certain service but has not licensed to do so due to some sort of limitations. They may use external companies that “assist” by providing invoices on their behalf – at best, this practice is a legal gray area; in extreme cases, they could be using fake invoices outright. You may ask, why should this concern me as the service recipient? In fact, the Supreme Court ruled that it is the responsibility of the service recipient to ensure that the issuer of the invoice is a licensed dealer. For instance, if someone provides me with an invoice issued by “Company X Ltd.” – who is Company X Ltd.? It is my responsibility to verify whether the person providing me with the service is authorized to do so.

What are other classic VAT pitfalls?

Is my transaction subject to regular VAT or is it VAT exempt? I, of course, assume that it’s a zero-rate VAT service. Why? Because I read it somewhere. I’m joking, obviously – but the fact is that it would be to my benefit to assume so since zero-rated VAT means I can reduce my prices by 17% and be more competitive. But what happens if it turns out afterwards that the service I provided was in fact subject to regular VAT? I’ll be forced to absorb that loss, since I can’t reasonably approach my customers and demand additional payment. Therefore, it’s prudent to thoroughly check the legalities.

Which businesses are at highest risk to be audited?

In terms of VAT fraud, the businesses involved are most often service-based and less frequently trade in goods. Two industries at high risk are human resources and construction services. When it comes to trade in goods, transactions on certain high-VAT goods may have a high number of fraudulent invoices – for example fuels and precious metals. Particular caution is needed when using a manpower service, such as a cleaning service. These need to be a serious part of the risk calculation for any contractor or dealer.

How can I lower my risk?

They should instruct and assist you with a high level of service and consideration, so you’ll be able to call on them at any time for advice on day-to-day dilemmas you encounter. The challenge is that many times people are more focused on doing successful business and less on the compliance. That’s why having an adviser available to keep track on those issues. Someone you can really depend on.

Second, do your homework and know what you’re dealing with. Launching a business is a responsibility that goes beyond simply waking up every morning and selling a product. You also a responsibility to maintain a bookkeeping system and understand how to use it, whether that means producing receipts and invoices in a timely manner or managing a computer system.

What should I check in tax invoices?

An invoice must be legally valid. That sounds simple, but here’s where it can become complicated: “legally valid” means both from a formally and substantively. Formally, that means the invoice must contain all the details required by law. First, you must have a licensed dealer number and contact information. Second, the invoice must be addressed to the recipient of the service or goods, including their official details as registered with the authorities. The invoice must contain full details of the nature and scope of the service provided in the transaction, or the types and quantities in the case of goods.

Substantively, the invoice must reflect the transaction between the parties actually providing and receiving the services, otherwise it is not legal, and therefore considered fictitious. This is dramatically significant.

Sometimes it’s just a matter of simple human error that ends up being labelled as fictitious, which seems like an overstatement.

To the average person, “fictitious” implies dishonesty or something that doesn’t actually exist. Obviously, there is a big difference between an intentionally fictitious, or fake, invoice and those that meet that legal definition. But in our professional sphere, invoices with errors are considered legally noncompliant and therefore fictitious. I’ll discuss the consequences of a flawed invoice that is determined to be illegal or fictitious. There is a range of outcomes, starting with the fact that the invoice cannot be used to offset the input taxes included in the transaction. Other consequences are more severe, including invalidation of the business’s books, which has much more significant financial consequences and possibly even criminal liability. After all, tax offenses are criminal offenses for all intents and purposes. As such, the consequences can be severe.

The State has created more and more systems for taxation. Obviously, it’s better to avoid problems. But if I did end up with a problem as a result of human error and discovered that I owe back payment on VAT, what could be done to manage the damage?

Let’s tackle this question in two parts.

In one scenario, let’s say this was the result of a bona fide mistake. Should you try to fight? Absolutely. It’s not the end and it is unequivocally worth the effort. The tax authorities often assume auditees will not fight the findings of an audit. The authorities’ goal is to recover as many taxes as possible, so they have a vested interest in interpreting any legal gray areas that turn up in the course of an audit in the most restrictive way possible. However, that does not mean the auditee must immediately accept their conclusions without question and pay. Legitimate differing interpretations of tax law are the basis for legal deliberations like these, and therefore there is little risk in appealing the conclusions in most cases. You can insist on your legal interpretation, and even if an assessment is issued, there’s no reason to panic. Assessments can be appealed, and failing that, an appeal as of right can then be issued to the district court, and the disputed taxes don’t need to be paid during this process.

On the other hand, these problems could be the result of poor judgement rather than an unintended mistake. Unlike the previous scenario, the auditee does have a lot at risk in this second scenario. Rather than just the taxes being at stake, the consequences now are much more severe sanctions, potentially even criminal prosecution resulting in heavy fines or even curtailing of freedoms in the extreme cases. Therefore, it’s critical to proceed with caution in this scenario. There is a significant difference between specialists in the field of taxation, and at this point the interpretation and legal protection required makes it a matter for lawyers rather than accountants.

Any final VAT advice?

My recommendation is not to leave anything to chance. Don’t assume you’ll get lucky and avoid being audited. Instead, assume you will need to be prepared for an audit at any moment and manage your taxes with the appropriate level of thoroughness and care.

meet our team VIEW ALL PRACTICE AREAS

YEtax Real Estate Tax expert Adv. Roy Grilak shares his contribution and additional insights from his interview by Globes Israel on the matter of Land Appreciation Tax

Original Hebrew publication in Globes written by Ela Levi-Weinrib

How will the Supreme Court ruling over capital gains tax affect other cases?

In the case ruling of Shlomo Nehama, the issue in dispute was regarding the liability for Land Appreciation Tax for the sale of a luxury apartment that was sold for NIS 45 million. Immediately after the sale, the tax authority knocked on the Nechama’s door and demanded a tax on the sale. At the heart of the dispute between Nechama and the tax authority was a renovation which he carried out in the luxury apartment he purchased. Until that renovation, the apartment was completely naked (no toilet, shower, kitchen, etc.), and was considered an empty “shell“ of an apartment.

In the sale of a residential apartment, the seller is granted an exemption from Land Appreciation Tax, while the sale of an apartment shell that is not suitable for living, does not qualify for an exemption. The problems of the tax authority were with the timing of the renovation, with the quality of the finish that is not suitable for a luxury apartment and also with the fact that the purchaser was not interested in the renovation at all and wanted to design the apartment as he wants.

We learn from this ruling that taking an initiative in order to “enter” the scope of tax exemption is a legitimate action. The message that comes out of the ruling is the confirmation of the Supreme Court’s well-known statement that the right to tax planning is part of the taxpayer’s property rights, and he is entitled to economize his steps in order to pay the minimum tax possible. The fact that Nehama hurried before the amendment to the legislation came into force in order to benefit from an exemption from Land Appreciation Tax, is a legitimate tax planning, since he acted in accordance with the law.

It seems that the Supreme Court criticized the position of the Tax Authority by stating that the main goal is the collection of Real Tax, in light of the language of the law and its purpose, and the Tax Authority should not try to give a different interpretation that will result in tax collection at the highest possible rate.

The market cap of crypto-assets was estimated – at the end of 2021

– close to $3 trillion, and 110 million crypto wallet holders are suspected globally[1]. According to the World Economic Forum, as of March 2022 there are 18,142 crypto-currencies and 460 exchanges. Cryptocurrency and blockchain are here to stay and as they continue to move up into mainstream, their economic significance is too big for the taxing authorities world-wide to ignore.   Governments are hurrying to design new tax and reporting rules for crypto; also for Israel the involvement of its tax payers in virtual currencies has substantial significance, in more than one way.

Many regulating international organizations are eager to develop policies to control, regulate and tax the trading and ownership of crypto.   And this time, again, it is the tax bureau of the OECD who are picking up the glove: the OECD has been preparing for over 2 years to table a proposal for the taxation on crypto and create reporting obligations for virtual transactions.  So now, at the end of March, OECD tabled the first part of its plans, and its’ ambition is to have everything in place by the end of 2024.

The crypto’s speedy history

Only a year after Nakamoto’s 2009 paper on Bitcoin, the first pizza was bought with bitcoin in May 2010, followed by Bitcoin reaching parity with the US dollar already in February 2011. After the launch of Ethereum in 2015, after some critical hard forks in subsequent years, after the first decentralised autonomous organisation (“DAO”) saw daylight, after the 2017-2018 initial coin offerings’ boom, and after the 2019 creation of Libra, starting 2020 also institutional investors investment in virtual assets.

Tax authorities and regulators around the world have been thinking how to tackle the many aspects and challenges of digital currencies. In 2018, the Financial Conduct Authority’s taskforce issued it’s a report regarding crypto-assets followed by other reports from numerous organisations among which the European Central Bank, IMF, European Commission, FATF, the US Federal Reserve, and that of the US Financial Stability board landed this year, in February.

Policy makers are wrestling to figure out which are the right monetary policies, how to secure consumer and investor protection, safeguard market stability, stop money laundering, find suitable accounting rules, and, last but not least, force crypto trading in a tight corset of tax legislation and compliance. All of these should actually encourage the new ecosystem and the development of game-changing technologies in fact serves public interest; their take on matters is not per se hostile to crypto and they are aware that the technologies underlying the world of digital assets offer immense alternative applications, far beyond fin-tech alone.

Unlike conventional monetary means, today, crypto does not involve the intervention by traditional financial intermediaries nor a central administrator  with visibility on crypto ownership or transactions.  A recent research report by the EU claimed that €850 million[2] (US$985 million) in tax could have been collected, on Bitcoin dealings alone (the largest of the virtual currencies) in 2020, when national tax rules would have applied.

Global Tax Ambassador; the OECD

After the OECD’s BEPS tax plans put the dormant OECD organization back on the map in 2015, quire dramatically, it became the ‘legislator of the new international tax order’. So, also this time around OECD’s tax committee will act with the speed of lightening and turn draft crypto tax plans – meant for discussion – into reality in no time, probably also now without stopping a second to breathe or listen.  The same happened with the BEPS reports. It is time to get prepared.

OECD’s obligatory standard for exchange of financial information by banks and financial institutions (the CRS), which was published in 2014, seeks to ensure transparency regarding cross-border financial investments to prevent tax evasion. However, crypto-assets are not under the reach of the current CRS rules. And even if they were, crypto can be owned by individuals in cold wallets or in crypto exchanges that are – today – not under any disclosure obligations.

In its’ original 2015 BEPS Action 1 Report, Taxing the Digital Economy, the OECD already mentioned governments wanting a slice from the global virtual currency trading.

In 2020 the G20 ordered that framework for the exchange of crypto information would be designed, driven by their concern that the invisibility of digital assets undermines global tax transparency. Digital assets such as cryptocurrencies, utility tokens and NFTs bypass traditional intermediaries, like banks and brokers, and conventional tax reporting mechanisms. Any reporting solutions would have to be integrated into the existing global exchange of financial information, the Common Reporting Standard (“CRS”). A report from the Accounting Office of the US government – based on statistics from the US tax authorities – shows that taxpayer compliance is above 95% when third party information reporting exists, while it is below 50% when no such rules exist.

After the OECD put together a first detailed inventory of taxation of crypto world wide, Taxing Virtual Currencies, in 2020, its think-tank set out to develop a plan to achieve  crypto transparency and propose amendments to the CRS to bring new financial assets and crypto intermediaries under its reach.   In the mean-while, the Biden administration already – in March this year – issued an executive order laying out U.S. efforts to regulate the crypto world and its intention to create a US central bank digital currency “CBDC”.    OECD wants to prevent a chaos of regulatory policies across the globe by pulling all countries together in a unified framework.

So, in March this year, OECD released already its’ detailed proposal for a Crypto-Asset Reporting Framework (“CARF”) including a set of intended amendments to the global CRS, to embrace crypto. The proposals predict crypto exchange of information bringing ‘digital intermediaries’ under stringent and serious reporting obligations. And OECD wants everything in place by the end of 2024.

CARF

The OECD, EU and US all aim strap the reporting-net around the new generation of digital “middlemen” – digital assets service providers – including crypto exchanges, custodians and crypto wallet providers. Unlike institutions in the conventional financial sector, most digital asset service providers do not yet have systems or process required for the kind of compliance that will be demanded.

The CARF rules are connected to the concepts and due diligence requirements in the current CRS, and the anti-money laundering (AML) and countering financial terrorism (CFT) guidelines; digital currency service providers will have to run know-your-client (KYC) on their customers’, ensure clients are registered with the tax authorities, collect and exchange financial information, ensure data are stored in a compliant manner and classify corporate clients. These are all huge tasks that may require separate compliance departments and dedicated software.  There are not a small burden for small intermediaries.   Certain voices in the industry claim that still disclosure may not be guaranteed, because anyone with a good lap-top can access decentralized finance applications without a traditional custodian or broker allowing circumvention of the reporting rules by setting up an own Bitcoin node.  The CARF is not exhaustively clear which crypto assets are in scope and does not detail which rules apply to decentralised finance (DeFi) and who would be the responsible persons for trading through smart contract transactions, such as a DAO, which have no intermediaries and are accessible by anyone with an internet connection.

Digital service providers may have to comply with OECD’s CRS, EU’s DAC-8 and the US’s FATCA reporting regulations, they will also have to demonstrate that their processes and controls are sufficient, and their directors will be personally responsible for ensuring compliance. In 2021 the Financial Action Task Force (FATF) already ruled that digital asset service providers must obtain a “license” and should be supervised.

The costs of IT solutions and other investments required for service providers will raise a very high barrier for new intermediary businesses wanting to enter the market; and this may actually frustrate market competition.

Tax and reporting of crypto within 2 years

The OECD’s draft of the CARF, predicts that reporting regulations such as the Common Reporting Standard (CRS), the eighth EU Directive on Administrative Cooperation (DAC-8) and the US’s Foreign Account Tax Compliance Act (FATCA) will soon apply to digital asset service providers, if OECD has it its way, by the end of 2024.

The OECD is now internalizing the responses to its plans from the public received at the end of April, and the basis thereof it will finalise the rules and its’ amendments to the CRS.    The G20 are expecting that the OECD will report back with a final text by October 2022 at the occasion of the next G20 summit. And – as has been customary – the G20 will probably approve without much ado.

[1] https://www.statista.com/statistics/647374/worldwide-blockchain-wallet-users/

[2] Thiemann, A. (2021), Cryptocurrencies: An empirical View from a Tax Perspective, JRC Working Papers on Taxation and Structural Reforms No 12/2021, European Commission, Joint Research Centre, Seville, JRC126109.