An Israeli district court has ruled that taxpayers cannot break an agreement with the Israel Tax Authority (ITA) by suddenly filing a legal opinion that takes a different position.

In Weiss vs Large Enterprises Assessing Officer, the court said the ITA also cannot back out of an agreement with a taxpayer. (The ITA sometimes needs to remember that.)

The main facts: The taxpayers in this case were a husband and wife. The wife owned eight commercial properties that she had received by way of gift or inheritance. The husband owned two residential apartments. The couple held shares in a company that owned five more company properties. All the properties were rented out.

The husband also happened to be 100% disabled for the purposes of Income Tax Ordinance Section 9(5), which grants a larger exemption for active income (up to NIS 684,000) and a smaller exemption for passive income (up to NIS 81,960).

So, the couple claimed his exemption against her rental income and said it was active income. They wanted the larger exemption.

But the ITA didn’t like this one bit and persuaded the couple to sign assessment agreements covering the years 1995-2001 and the years 2011-2014. These said in those and later years, only 15% of the wife’s rental income would be allocated to the husband as his active rental income.

Six months after signing the second agreement, however, the couple filed a joint tax return for 2015 and claimed an active-income exemption for 100% of the wife’s income.

The ITA took a dim view of these tax-planning shenanigans. But were they legal?

The issues: The main issues were: (1) Is the rental income active or passive? (2) Can a joint tax return be filed? (3) Can the husband’s disability exemption be used against the wife’s rental income?

The judgement: The court found that the rental income was indeed active business income due to the number of properties, their management, and the knowledge needed of the real-estate market.

The court also found that joint tax returns were allowed by the Tax Law. Moreover, the court said the husband’s disability exemption could in principle be used against the wife’s property rental income in a joint tax return.

Nevertheless, there was a problem. Their 2011-2014 tax assessment included a stipulation that the agreement would continue to apply to later years. Therefore, the court ruled that the couple had to stick to the ruling in later years.

That meant the taxpayer couple could allocate only 15% of the wife’s rental income to the husband in the subsequent years concerned, as previously agreed upon with the ITA.

The court was emphatic about keeping to agreements and ruled: “To conclude, when the appellants (the couple) chose to sign the assessment agreement for the years 2011-2014… which included an express obligation to apply it also in subsequent years, given the process before the signing, the appellants also gave their agreement to this percentage (15%) in subsequent years and thereby waived any other claims.

Comments: In short, an agreement is an agreement that cannot be changed unilaterally by a taxpayer nor the ITA. This refers to “assessment agreements” reached after the relevant transactions took place according to the above cases.

As for advance tax rulings, the law expressly says they also cannot be changed unless there is a change in the circumstances.

As always, consult experienced tax advisers in each country at an early stage in specific cases.

leon@hcat.co

The writer is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.