August 26 2011
InMoskovitch v Assessing Officer of Haifa(August 4 2011),
the taxpayer was a controlling shareholder of a public company. In 1999 the
company ran into financial difficulties and in 2001 it underwent reorganisation
proceedings. However, these failed and in 2003 it was put into liquidation. The
company accounts showed that the taxpayer's outstanding debt had accumulated
over many years as a result of withdrawals (or loans) from the company. The
assessing officer grossed up these loans and assessed the tax due thereon as
employment income. The assessing officer agreed to tax the outstanding amount,
comprised of the principal and those agreed-upon loan provisions that related
to linkage differentials and interest.
The appeal raised
·Did the loans constitute taxable income of the taxpayer?
·When did the loans become includable in income?
·What was the exact amount of the loans?
In answer to the first
question, the court held that the loans had been informally written off - the
circumstances surrounding the loans proved that the company would not attempt
to collect the loans, no collection effort had been made by the liquidator (who
explained that the taxpayer had no assets with which to repay the loans and
consequently enforcement proceedings would be futile), and the taxpayer himself
demonstrated no effort to repay the loans. The court therefore classified the
loans as income from the company to the taxpayer.
When considering the
second question, the court showed the taxpayer leniency. It agreed that the
growth of the loans between 1996 and 1999, the taxpayer's inability to repay
the loans in 1999 and the lack of any attempt by the company to enforce
repayment of the loans all suggested that the write-off occurred in 1999. It
rejected the contention that since the loans were employment income, they had
accrued over previous years on which the statute of limitation had run out.
Nevertheless, the court decided to regard the loans as having been written off
in the year most beneficial to the taxpayer. If this year was after 1999,
interest and linkage differentials would continue to accrue until then.
In deciding the third
question - the amount of the loans - the court considered the company accounts
and rejected the contentions that:
·the interest charged was excessive;
·no linkage differentials and interest should be added to the
loans until their inclusion in income;
·a notional fee for a guarantee by the taxpayer of the company's
loans should be offset against the loans; and
·payment made by the taxpayer's father and credited to him should
reduce the amount of the loans.
It did, however, find
that severance pay due to the taxpayer and certain amounts due on insurance
policies to thetaxpayer which the company seized were to be offset against the
The court was aware
that if the loans constituted income, no corresponding deduction would be
available to the company, because the statute of limitations had apparently
expired with respect to its assessments for the relevant years. It therefore
decreed that the tax on the loans be levied as if they were a distributed
dividend (taxed at 25%) in order to take into account the company tax levied at
the corporate level.
The main lessons for
the taxpayer fromMoskovitchwith respect to income from debt
write-offs are that:
·loans received from a controlled company should be repaid
gradually and continually in order to avoid classification as income; and
·the controlled company should take action to collect the loans
in order to avoid adverse tax consequences.