International taxation - Individual income tax – consolidated / separate calculation: Malkieli ruling

On February 1st, 2012, the Supreme Court issued a new ruling regarding the individual taxpayer’s entitlement to consolidated or separate calculation of the tax liability of the taxpayer and his\her spouse (the Malkieli case). It should be emphasized that in a separate calculation, each spouse’s tax liability is determined separately (including the entitlement of credit points and lower tax brackets) and usually that kind of calculation is favorable to the taxpayer. The Malkieli case set a new binding precedent, which changes a previous ruling from 2003 (the Keles ruling).

The appeals deal with three married couples. In each of the cases, the spouses were working at the same company, while at least one of them is holding 96% – 100% of the company’s shares.

The couples claimed the separate calculation approach in their tax returns, as it were, despite the alleged dependence between the sources of their income. According to the taxpayers, they demonstrated both the necessity of their employments and the implementation of the arm’s length principal on their wages. Since all concerned couples were employed in companies controlled by them, the assessing officers determined that, despite Keles precedent, the spouses’ incomes were dependent and therefore, an assessment was issued according to the consolidated calculation approach.

The court analyzes the legislation regarding tax calculation: paragraph 65 of the Israeli Tax Ordinance (“ITO“) states that both spouses’ incomes are considered as the income of the “registered spouse”. Paragraph 66(a) of the ITO allows a separate calculation for the unregistered spouse for his/her income derived from personal exertion, a profession or employment. Separate calculation entitlement is restricted by paragraph 66(d) of the ITO, which sets conditions to be met. According to the court’s opinion, that paragraph is to be divided into two separate parts:

1. First, the spouses’ option to separate calculation is denied if generally, their incomes are “dependent”. The intent is to examine the ability of one spouse to decisively influence on the other spouse’s employment’s conditions and salary.

2. At a second separate stage, enumerates three conclusive presumptions, in which cases the spouses’ incomes are deemed to be dependent.

The court attempts to distinguish his decision from the Keles precedent, which stated that the three presumptions mentioned above are rebuttable presumptions. However, a profound reading of the new ruling shows that the court sets a new precedent: according to Keles ruling, the end of the paragraph mentioned above has a subjective purpose of “preventing tax reduction” and an objective purpose of “realization of the right to equality” (preventing discrimination between couples and individuals etc.) The outcome of that second purpose is that the presumptions are rebuttable and therefore, the independence between the two spouses’ incomes can be proved in order to implement the separate calculation approach. However, the Malkieli ruling reaches an opposite position, stating that the wording of the law clearly shows that the presumptions are conclusive and not rebuttable ones, and that it is hard to think of a reasonable interpretation of the contemplated paragraph which finds a basis for the argument that a separate calculation can be implemented while the spouses’ incomes are dependent. The ruling emphasizes that indeed, a tax law can be interpreted according to its purpose, but a preliminary condition for such interpretation, is the existence of a foundation to such interpretation in the wording of the law.

Therefore, according to the ruling, paragraph 66(d) must be narrowly interpreted, i.e, denial of the separate calculation for the spouses when the circumstances fit one of the enumerated presumptions, even if there wasn’t any intent of tax reduction.

We note that at the end of the verdict, court determines a vague “fact”: “Therefore, because there is no dispute that there is a dependence between incomes when the couple holds 100% of a family company, and because there is no doubt that In such a situation, the salary level of each spouse is affected by the other spouse’s wage and decisions, it must be determined that their incomes are to be calculated jointly.”

Despite the harsh ruling, the Court finds that the legislator should amend the law: “One can hope that the legislator should consider whether the wording of paragraph 66(d) of the ITO is still relevant today, 55 years after its legislation… This is a clear case that shows the distance between the existing law and the desired one… no need to add tax considerations to the list of reasons that weaken the family unit. This is a law that in certain circumstances creates a discrimination against married couples by granting tax advantages to unmarried couples.”