Your Taxes: Returning to court with new information after tax rulings ruled to be bad faith

The Israel District Court ruled that going to court may be wrong, and going back to court with additional evidence may be bad faith. At least, that’s what it did in the case of Henry Schwarzbaum Vs. Rehovot Assessing Officer (58143-01-23, Judge S. Bornstein 16.8.26). What’s going on?

Currently, Section 102 of the Israeli Tax Ordinance enables gains on options and stock to be taxed at 25%. This is markedly better than other tax rates related to one’s salary, which can go up to 50%.

However, for stock issued before 2003, tax rates of up to 50% were applicable to gains from stock of a foreign parent corporation – namely, Applied Materials.

In 2013, the taxpayer went to court, claiming that the 25% tax rate applied because he exercised the pre-2003 options after 2003. The court rejected this, imposed up to 50% tax, and made him withdraw his 2013 lawsuit.

In 2021, the taxpayer discovered at the tax office that, back in 2003, he had filed a deemed sale & repurchase election under Section 102 regulations for traded securities like Applied Materials. This meant that, had he made an actual sale, he would’ve been eligible for the 25% tax. But now, it was too late.

In the second case, the court again ruled against the taxpayer, saying he should have remembered to invoke his election previously. Therefore, the court ruled that the ITA did not act in bad faith, but that the taxpayer did (Paras 38, 46). He also misconstrued two tax rulings obtained from the ITA on December 22 & 23, 1996.

The court’s judgment does not give exact dates or figures. So, let’s illustrate what might have happened.

Suppose Mr. X was granted 10,000 Applied Materials (AMAT) options at their market value on January 1, 1994.

The value of 10,000 options, once converted to stock, increased from a cost of $23,600 (in 1994) to $304,000 (if sold at the end of 2018). If sold now, that would amount to roughly $4,445,000.

That is a sizable increase. And the entirety of it is taxable. If Mr. X had to pay the 50% tax instead of 25%, he would stand to lose a lot of money.

So, why should the taxpayer have to lose so much, simply because he forgot he had filed the repurchase election many years ago?

We can learn a few lessons from this tragic case.

First: keep a copy of everything. Especially if it’s important.

Second: the ITA is under no obligation to tell you anything or give you anything. Tax officials are public servants, but they don’t necessarily serve the public.

Third: if you discover something too late, it’s too late. But, if the ITA discovers something, the ITA is allowed to reopen the case within various time limits, typically 6 years after an assessment, if any, was issued (ITO Sec 147).

Fourth: beware of pushy tax investigators who try to put words in your mouth. In this case, an investigator tried, albeit unsuccessfully, to make the taxpayer agree he had enjoyed a tax deferral. He knew there no tax to defer (because stock options were issued at market value).

Fifth: make sure any and all tax rulings are crystal clear. In this case, the ITA thought it agreed in two rulings on two consecutive days to defer tax. The taxpayer thought the ITA had also agreed to reduce the tax rate from 50% to 25%. Needless to say, the two parties didn’t see eye-to-eye there.

Seventh: because of doubts about the quality of the Israeli justice system, many taxpayers and their advisers settle with the ITA rather than risk it in court.

Eighth: many taxpayers don’t know where their ESOP documentation is and assume the Human Resources department can provide a copy. Do not presume this to be the case.

As always, consult experienced professional advisors in each country concerned at an early stage in specific cases.