An income tax circular which was published by the Income Tax Authority in Israel (hereinafter: the “ITA”) sets forth criteria for the Tax Assessor at the time of determining an assessment for a taxpayer who does not possess the reference documents to substantiate the existence of any particular expense or the cost of any particular asset, and the amount thereof.

In the general background for the Circular, the ITA determines the following:

“In cases where there are no documents to show the existence of an expense or to prove the cost of an asset, for the purpose of the determination of the taxable income, this shall not constitute an impediment to the claim and recognition of the expense or the cost of the asset.”

The Tax Assessor shall permit the taxpayer to deduct such expense, once he has been satisfied that it indeed incurred in accordance with the circumstances of the case, whilst examining the nature and the purpose of the expense.

Inter alia, the Tax Assessor is required to examine the amount of the payment actually made in respect of the expense, to identify the receiving party and the means of payment thereto (and also the identification of the recognition of the income by the receiving party / the customer). In addition, the Tax Assessor shall examine other relevant documents pertaining to the requirement of the deduction of the expense, such as: agreements and contracts between the parties, an appraisal or other documents substantiating the value of the asset, the records of administrative authorities, affidavits of the parties, and so on and so forth.

Insofar as the taxpayer fails to comply with the burden of proof as stated above, the Tax Assessor shall assess the expenses and the taxable income of the taxpayer based on economic reviews, hypotheses and estimates as per standard practice in the industry in which the taxpayer is engaged, and pursuant to the guidelines of the ITA for examining the reasonableness of the income. The welcome provisions arising from this Circular perpetuate the trend, as can be seen in recent case laws in Israel, in all matters pertaining to the justification that is required from the Tax Assessor when he comes to increase the assessment, in cases where the taxpayer’s books have been properly kept.

In our opinion, it is necessary to adopt the provisions of this Circular also for the examination of the deductible expenses and costs at the time of the calculation of land appreciation pursuant to the Real Estate Taxation Law, even in the absence of such documentation, and also at the time of the examination of the increase in the taxpayer’s assets and capital, for tax assessment’s purposes.