Israel arrested tax investigation against U.S CA software giant to avoid Pandora’s box that would threaten defense relations, Calcalist

Israeli newspaper Calcalist revealed that the State Attorney’s Office ordered the Tax Authority to end a criminal investigation against a subsidiary of the US software giant CA, among other things because of concern about damage to the foreign and defense relations with the US.

According to Calcalist, at the center of the investigation they conducted was the suspicion that CA Israel, a US subsidiary of CA, was working to conceal income of $8.5 million. These funds, according to the investigation, came from the US defense budget that Israel provides to Israel every year, and are supposed to be used mainly to purchase equipment of various kinds from American suppliers.

The investigation also revealed that the defense aid funds were transferred from the Defense Ministry to CA Israel, even though the agreement was signed at all with the American company. The Income Tax authorities suspected that the transfer of funds to the US was intended to evade payment of tax in Israel, in order to create a representation that the income was produced there and not in Israel.

However, CA Israel claimed that the parent company had been asked to transfer money to the United States for an audit of the use of the aid money and that they were merely correcting a mistake in the reports.

In order to gather sufficient evidence on which to decide whether to file an indictment, the Income Tax authorities should have investigated senior CA officials.

This is to understand and confirm who exactly gave the order to transfer the funds, and what really was behind their transfer. However, at the top of the State Prosecutor’s Office, which the issue is being raised with the fear that there are other significant evidentiary difficulties in the case, they believed that a request to investigate the US, which would expose the use of security aid funds, could harm relations with the American administration.

The case was transferred to the Tax Authority’s ransom committee, which ruled that CA Israel would pay a ransom of $2.5 million to file the case against it and against its officers who were investigated under a warning. A ransom arrangement is actually a compromise agreement in which the company pays money without admitting anything, and without it being subject to judicial review.

Aggressive tax planning or compliance

The CA investigation, which develops security software and enterprise resource management software, touches on events that took place about a decade ago. At that time, the company was linked to the Ministry of Defense for the sale of millions of dollars in software, but the money went to the subsidiary CA Israel, which is based in Herzliya Pituah.

A few years after the transaction, the Income Tax Authority conducted an audit of the CA Israel reports and discovered a one-time expense of NIS 30 million ($8.5 million) in favor of the parent company, raising the suspicion that it was fictitious, because the marketing services, the sale and supply were made in Israel by the local branch, and the issue discussed was where the revenue was generated, that is, where the transaction actually took place.

If the income of the company was produced in Israel, the tax on which it should have been paid in Israel; But if it really was done by the American company, as the use of defense aid money requires, then the tax payment would have to be in the United States.

The Tax Authority’s concern arose against the backdrop of a common tax planning being conducted by multinational companies operating in Israel. In the framework of the transfer pricing mechanism, which states that an international company pays for the services provided by the local company, and only on this payment is the local company paying tax, the international companies often make a lower payment than does the services they received.

Another method used by many multinational companies is the charging of expenses to the branch in Israel, while the revenue from the branch is transferred abroad so that if the multinational company is registered in a country where the tax rates are lower, it ultimately pays less.

The income tax investigation found that registration of the one-time expense was so large that the CA’s headquarters in the US claimed that the money paid to CA Israel from the Ministry of Defense was from the US defense budget.

CA’s management was afraid to get involved with the US authorities, so they testified, and therefore ordered the money to be transferred to the parent company, which was given several years after the money was received at CA Israel.

CA Israel, represented by Attorney Pinchas Rubin of Gornitzky & Co., also claimed that no tax offense was committed, meaning that CA only corrected a mistake in which the Israeli company reported revenues that had to be registered in the US. This income, the company says, also paid a tax in Israel, so that no money was deducted from the state budget and no offense was committed.

The company also argued that income should not have been recorded in Israel for two reasons. First, because this registration did not meet the conditions for using the aid money; Second, the deal was signed between the Defense Ministry and CA in the United States and not with the company’s Israeli branch, so the money had to be transferred directly in advance.

According to the respondents, when the company discovered retroactively several years later and following a request from the US authorities that the money should not be recorded as income in Israel, an adjustment was made in the reports – neutralizing the income by recording the expense.

The investigation ended with a ransom of NIS 9 million ($2.5 million)
 
The income tax authorities were not enthusiastic about the company’s explanations, and those close to the investigation believed that the evidence collected might be enough to file indictments.

However, the Tel Aviv District Attorney’s Office (taxation and economics), which accompanied the investigation, though there was a hole in the case: There are no versions and testimonies of those involved in the United States of the CA employees in the United States who ostensibly gave instructions to transfer the funds, which were supposed to be channeled to American suppliers. Without these versions, the prosecution believed, there is insufficient evidence to establish a reasonable chance of conviction. The solution in such cases is to carry out an investigation. In other words, to ask the US authorities for mutual assistance, so that Israeli tax researchers can investigate the CA officials in the US.

The issue was resolved by the State Attorney’s Office, where they thought that a request to question the US might raise questions from the US authorities about the use of security aid funds, a subject that could cloud or hurt sensitive relations with the US. Therefore, they believed that the public interest in reaching the truth and perhaps collecting real taxes was backed by the public interest in maintaining security relations with the United States.

In light of this, it was decided not to carry out additional investigations, and the matter was transferred to the Tax Authority’s ransom committee. The committee understood that without a hearing it would not be possible to obtain sufficient evidence to establish an indictment, and therefore they decided to offer CA Israel NIS 9 million ($2.5 million) as part of a settlement arrangement. CA paid the sum, and the file was closed.

The Justice Ministry said in response to Calcalist: “We do not respond to such matters.” The Tax Authority said in response: “We can not relate to the issue.”

CA said in response: “The company complies with the laws of all the countries in which it operates, and cooperates with the Israeli legal authorities regarding the company’s tax documents.”

Americans against shekel security assistance

The defense budget that the US transfers to Israel constitute a large component of Israel’s defense budget, for example, this year, US defense aid totaled $ 3.1 billion (NIS 12 billion) out of a total defense budget of NIS 70.5 billion ($19.8 billion).

Israel is unique in its security assistance from the US, not only because of its scope, but also because the government allows it to use part of the sum in shekels to buy from local suppliers, but this issue bothers the Americans who want to make sure that aid to Israel will serve the American industries.

Thus, the aid agreement signed last September for the years 2019-2028 has indeed been presented as unprecedented since it includes $ 33 billion in aid over a decade but includes a gradual reduction in the conversion of aid money into shekels. Those who are mainly affected by this are small Israeli industries since the big companies have American subsidiaries through which they can use the aid money.

There is, in any case, a certain kind of cooperation between American and Israeli companies. Although the Americans are not even committed to this, they tend to accept the rules of reciprocal procurement in transactions made with security aid money.

By Tomer Ganon and Omri Milman, Calaclist (Read the Hebrew version)