A Precedent Supreme Court Verdict: the Israel Tax Authority is Prohibited from Piercing the Corporat

 

Adv. Gill Nadel, Adv. Omer Wagner, Accountant (Jurist) Amit Zomer

The Israel Tax Authority targets individuals engaging in tax evasion, regardless if the evasion relates to direct taxes or indirect taxes.  

Occasionally, the taxpayer decides to "outsmart" and close the business under which the tax debt is registered, and establish a new business with similar activities, to which clients are transferred to and "business is continued as usual".

Are these situations hopeless for the Israel Tax Authority, in the manner in which it cannot collect the tax debt which in turn turns into bad debt?

Recently (May 18^th 2014), the Israel Supreme Court ruled a precedent verdict which declared that in these situations, the Israel Tax Authority itself should turn to the court, file a claim against the active business, and request a legal action of piercing the corporate veil between the active company and the original tax debtor. This ruling relates to two appeals united into a single deliberation.

The Israel Tax Authority claimed that due to its collection authorities it is entitled to pierce the corporate veil by itself, without turning to the court, and that actually the business owner is the one that should claim against the authority's piercing of the corporate veil in court.

The court ruled that in spite of the fact that the Israel Tax Authority's wishes to battle tax evasion should be honored, its authorities should not be expanded beyond its authorities under the law. The court ruled that the Israel Tax Authority's power to pierce the corporate veil by itself is reduced to circumstances clearly described under clause 106 to the Value Added Tax Law, and do not extend beyond it.

 

The Case Facts and the Parties' Claims, in the Matter of Zeiton:

The matter relates to three companies belonging to the Agbaria Family, as in the Olive Press company ("the first company"), Mohamed Agbaria is the shareholder; in the Basham Olive Press company ("the second company"), Mohamed's son, Basham Agbaria is the company's manager and his wife is the shareholder; and in the Zeiton Industries Ltd. company ("the third company" and together the "three companies"), the shareholder is Saeed Agbaria, Mohamed's grandson.

Towards the end of 2006, the Israel Tax Authority turned to the third company, Zeiton Industries Ltd., with a request to pay a debt of 714,000 NIS, due to a debt owed by the first company from the year 2000 ("the debt"); this request was made in light of the claim that the three companies are the same entity, which changed its name in order to avoid paying the debt owed by the first company. The Israel Tax Authority based its approach on the fact that the three companies are completely identical in various parameters, including the character of their activity, the brand's name, the company's practical management, the clients' identity, the company's employees, etc.

The Magistrates Court ruled that in light of the fact that clause 106 to the Value Added Tax Law, which authorizes piercing the corporate veil in a similar situation, was legislated after the debt was produced, it cannot be used; and that the Israel Tax Authority should have filed a claim against the company in court and should have requested the piercing of the corporate veil as defined in clause 6 (a) of the Companies Law. The District Court has also embraced this ruling.

In the appeal to the Israel Supreme Court, the Tax Authority claimed that it is highly significant to provide it with effective tax collecting tools for battling tax evasion; and it also claimed that its authority stems from clause 5 (1) (b) of the Tax Ordinance (Collection) and alternately, it is inherent authority.

 

The Matter of the Jerusalem Brothers:

The matter relates to two companies, the Brothers Meat Marketing Ltd. company ("Company A"), which was listed as a sole proprietorship towards the end of 2004, and the A. Jerusalem Brothers for Trade company ("Company B"), which was listed as a sole proprietorship towards the end of 2007.

In the end of 2007, the Israel Tax Authority issued Company A with a tax assessment of 1.7 million NIS ("the assessment"). Less than a year later, Company A discontinued its activities, and as a result, the Tax Authority attributed the tax assessment to Company B; this was done as the two companies were considered a single financial entity in light of the fact that they were completely identical in the identity of the shareholders involved, the identity of the clients and suppliers, etc. Company B claimed that there is no relation between it and Company A.

The District Court ruled that the Israel Tax Authority has no authority to pierce the corporate veil between the two companies, in light of the lack of explicit authority, similar to the Zeiton case; and furthermore, the District Court ruled that the Tax Authority did not withstand the instructions of clause 106 to the Value Added Tax Law, for the aforementioned piercing of the corporate veil.

 

The Israel Supreme Court Verdict:

Regarding the Israel Tax Authority's claims of inherent authority, the court rejected this approach while stating that "acknowledging the Tax Authority's inherent authority might reduce the principal of administrative legality, according to which the administrative authority is not authorized to conduct any action which it was not specifically authorized to conduct". Meaning, the court stated that in order to pierce the corporate veil there must be a legal source which authorizes it, while embracing the District Court's ruling that the Tax Ordinance (Collection) does not authorize it.   

Regarding the Tax Authority's approach that there is great significance to provide it with effective tax collecting tools, for dealing with situations in which tax evaders establish identical companies and transfer their business activity to the other company and leave the debt of the original company in its books, the court ruled the following: Despite the fact that in both cases discussed in the appeal there are identical companies to the debtor companies, "the various collection means are required to suit the principle of administrative legality, according to which an authority is not authorized unless that authority was instilled by law"; the court also ruled that in the current constitutional era, the inclination is to have an approach which reduces the harm to a constitutional right as much as possible.  

The court accepted in principle the Tax Authority's approach that the legislator asked to compare its authorities to the Head of the Writ of Execution, but determined that there is not enough to conclude that the Tax Authority has unlimited authority to pierce the corporate veil.

In light of the aforementioned, the appeals were rejected on behalf of the state and it was determined that the piercing of the corporate veil was unlawfully performed.

[Civil Appeal 216/12, the State of Israel - Customs and VAT Division vs. Zeiton Industries Ltd. and A. Jerusalem Brothers for Trade Ltd., given on May 18^th 2014, before Justices Meltzer, Amit and Shoham. The parties were represented by: Zeiton Company - Adv. Sadot; Jerusalem Brothers Company - Adv. Dechalduly; the Customs Authority - Adv. Linder].

Endnote:

According to the Israel Supreme Court's verdict, the authority to "pierce the corporate veil" is sometimes offensive and draconian, and the Tax Authority, being an administrative authority, could utilize this authority only in specific situations in which it has explicit authority under the law to do so. The court stated that:

"Piercing the corporate veil between companies is an act which requires judicial judgment and it would be excessive to provide this kind of judgment to the tax collector".

This verdict actually determines that when the Tax Authority is interested in piercing the corporate veil not based on clause 106 to the Value Added Tax Law, it should turn to the court and file a claim and request for piercing the corporate veil.

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This document provides a general summary and is for information purposes only. It is not intended to be comprehensive nor does it constitute legal advice. If you are interested to obtain further information or wish to follow the legal developments on this matter, please contact Adv. Gill Nadel - Chair of the firm's Import, Export and International Trade Law Practice, Tax and Executive Compensation Department. Email: Gill.Nadel@goldfarb.com, phone: +972-3-6089848.