Israel’s Anticipated, Pilot Voluntary Disclosures Program Gets a Rocky Start -- and Lessons from Canada’s Voluntary Disclosure Program (VDP)

Introduction: Israel’s Pilot Program for a Modern Crypto-Centric Voluntary Disclosures Program for Taxes Gets a Rocky Start

Generally speaking, voluntary disclosure programs are administrative programs offered by tax administrators to allow previously non-compliant taxpayers to correct their affairs if certain terms and conditions are met. In exchange for correcting tax non-compliance, tax administrators will offer valuable incentives, such as penalty and interest relief, or exemptions from potential criminal charges for tax evasion. Many developed countries, including Canada, the United States of America, England, Germany, and Japan, each operate voluntary disclosure programs of their own design, and to great effect.

Since 2019, no permanent Voluntary Disclosures Program framework has existed in Israel, and taxpayers have faced continuing uncertainty how to proceed with correcting tax non-compliance. On December 31, 2023, Israel took its first step in many years toward developing a modern Voluntary Disclosures Program, by issuing an administrative Order specifically focused around taxes on cryptocurrency assets.

In August 2024, the Israeli Tax Authority announced that its pilot voluntary disclosures program had heavily underperformed. The program had only yielded approximately NIS 30,000,000 (or approximately $CDN 10,000,000) in undisclosed income from Israeli taxpayers, falling well below the Israeli Tax Authority’s expectation that the program would yield hundreds of millions of Israeli shekels.

The underperformance of the program has cast a shadow over the Israeli Tax Authority’s newly anticipated permanent Voluntary Disclosures Program framework, first promised back in May 2024. To date, no draft Guidelines for the program have been published. And with the expiry of the pilot program, it remains to be seen exactly how the Israeli Tax Authority will incentivize taxpayers to correct tax non-compliance that it is clearly aware of. 

The purpose of this article is to compare and contrast the Israel Tax Authority’s pilot program, and the terms and conditions for a successful application, with the parallel Voluntary Disclosures Program (“VDP”) operated by the Canada Revenue Agency (“CRA”), Canada’s tax administrator. This article will then explore the possible reasons for the under-performance of the Israel Tax Authority’s pilot program, relative to the historic success of the CRA’s VDP. This article concludes by offering pro tax tips from our expert Canadian tax lawyers.

Summarizing the Israeli Tax Authority’s Pilot Program for Crypto Non-Compliance

In an effort to further modernize Israel’s tax system, on December 31, 2023, the Israeli Tax Authority announced a new pilot program to allow cryptocurrency owners with unreported taxes to correct non-compliance through voluntary reporting.

In recent years, Israeli cryptocurrency users have encountered heavy administrative red-tape when cashing out on their crypto assets. Many Israeli institutions refuse to allow the inflow or outflow of cash in relation to cryptocurrency activities, due to increasingly-stringent anti-money-laundering and terrorist financing laws. And because all taxes paid in Israel must be paid out of an Israeli bank account, many Israeli taxpayers have been unable to pay taxes on cryptocurrency proceeds all-together.

In Israel, cryptocurrency assets are generally treated as taxable assets. Any profits resulting from a disposition of cryptocurrency assets (e.g. a sale for cash, an exchange of tokens for other token types) can result in capital gains (taxable at a fixed rate of 28% for individuals) or fully taxable business income subject to Israel’s marginal tax rates. Similarly, in Canada, the income generated on a sale of a cryptocurrency asset could be characterized as a partially taxable capital gain from the sale of capital property, or fully taxable business income from the sale of inventory.

Under the program Guidelines, in exchange for voluntarily reporting previously undisclosed capital gains or income from cryptocurrency dispositions, the Israeli Tax Authority would assess taxes owing and refrain from levying penalties for previously unreported income. (Crucially, the Guidelines for the program state that applying for relief would provide no protection against further criminal proceedings under Israel’s tax laws or other laws, including money laundering and terrorism legislation.)

Under the program, penalty and interest relief would be limited to cases where the taxpayer met several specific conditions:

1. The taxpayer presented evidence of a refusal by an Israeli commercial bank to open a bank account due to their involvement in cryptocurrency. 
2. The taxpayer provided complete disclosure of details concerning his or her cryptocurrency activities, as well as information on any resulting taxable income and tax liability. This included a proactive disclosure obligation to provide information that could verify the source of funds, including (among other information): (i) a list of cryptocurrency wallet addresses; (ii) the taxpayer’s cryptocurrency transaction history; (iii) bank records in the taxpayer’s name verifying the source of funds for cryptocurrency acquisitions and deposits related to cryptocurrency sales.
3. The taxpayer undertakes to pay the taxes due, regardless of whether the application is approved or not. Those taxes could be paid through an Israeli bank, or a foreign bank, so long as the funds are paid out of an account in the taxpayer’s own name. (This exception was provided as Israeli banks have become increasingly resistant to accepting funds traced to cryptocurrency activities, due to increasingly stringent anti-money laundering and terrorist financing laws in Israel.)
4. The taxpayer consents to provide identifying information, which would be disclosed to Israeli authorities, including the Israeli Police, the Bank of Israel, and the Israeli Anti-Money-Laundering Authority, to confirm that no (i) active investigations were ongoing in connection with illegal activity or money laundering at the time of the disclosure, or for any family members or related parties (ii) the taxpayer and any family members were not previously under investigation for material tax offences or criminal matters, and (iii) the taxpayer and any family members had filed income-tax returns up-to-date at the time of the disclosure.
5. The taxpayer affirmed in writing the source of funds to acquire cryptocurrency assets was derived from legal income.
6. The taxpayer did not appear on a list of sanctioned individuals by Israel and other international bodies (including the European Union list, the OFAC list, the Israeli Ministry of Defense list, and sanctions lists prepared by the Israeli Ministry of Finance).

Once an application was filed, the disclosure would be subject to review by a senior investigator to ensure completeness, and to verify that the source of funds related to the taxpayer’s cryptocurrency activities was not suspicious or related to past criminal activity. The file would then be subject to approval by a separate deputy of the Israeli Tax Authority, who would issue a requirement to pay to settle the tax debt.

The pilot program was put into effect as of January 1, 2024, and operated for a period of six months, until July 1, 2024.

The CRA’s Voluntary Disclosures Program in Contrast

Under the Canada Revenue Agency’s Voluntary Disclosures Program (“VDP”) taxpayers have a broad, inclusive and critical tool for correcting serious non-compliance under Canadian tax law, and not just related to cryptocurrency tax. The CRA’s current iteration of the VDP for income-tax debts, captured in Information Circular IC00-1R6, has been in effect since 2017.

To successfully qualify for relief under the VDP, a taxpayer must satisfy five conditions:

1. The disclosure must be voluntary—in other words, the taxpayer must file the application before becoming aware of any audit or action by the CRA that could reasonably uncover the non-compliance being disclosed.
2. The disclosure must be complete—all instances of non-compliance, across all relevant taxation years, must be disclosed in an application.
3. The non-compliance must involve the application of a penalty—a disclosure cannot be made in circumstances where a penalty will not apply.
4. The non-compliance must concern a taxation year that is at least one year pats due—non-compliance that concerns the immediately-receding taxation year will not be considered for relief.
5. Payment for taxes owing must be made­—a taxpayer must either pay estimated taxes owing at the time an application is filed, or request a payment plan if taxes cannot be paid at the time of filing.

If an application under the VDP is accepted, in exchange for voluntarily disclosing errors or omissions in tax filings, the taxpayer will be eligible for relief from criminal prosecution, and in some cases relief from penalties and interest on taxes owing. This relief takes effect as of the date the CRA receives a disclosure application, if it is eventually accepted.

A taxpayer is also expected to provide all relevant information for correcting the tax non-compliance in question. This generally includes an explanation of the non-compliance, and any corrected tax returns, forms, and schedules, for the CRA to process. It is also expected that a taxpayer and any representatives will cooperate with the disclosure process, by providing any documents, records, and books required to verify the facts of a taxpayer’s case, but only if requested by the CRA. And a taxpayer is generally not punished for minor errors or omissions in a disclosure—so long as a taxpayer has taken reasonable efforts to provide information required to correctly report previously-undisclosed income, and even if the taxpayer is required to make reasonable estimates due to lack of documentation, the application may be considered complete.

Where Might the Israeli Pilot Program Have Gone Wrong?

In its August 2015 report titled “Update on Voluntary Disclosure Programmes: A Pathway to Tax Compliance”, the OECD acknowledged the pressing need for jurisdictions to develop consistent guidelines for voluntary disclosure programs. Tax cooperation between countries has accelerated rapidly in recent years, as well as exchange of information agreements. And countries worldwide have also moved toward harmonizing voluntary disclosure rules, in an effort to combat international tax evasion. As the OECD observed in its 2015 report, “Update on Voluntary Disclosure Programmes: A Pathway to Tax Compliance”, the primary concern often faced by taxpayers to make a voluntary disclosure is lack of certainty: will criminal charges be brought if a full and accurate disclosure has been made?

The CRA’s VDP is very clear on the matter of relief from criminal prosecution. To obtain a waiver from criminal prosecution, the disclosure must be complete. This is separate from whether income is sourced legally or illegally, and regardless of culpability for tax evasion. (Penalty and interest relief may be limited if the disclosure is considered under the Limited Program because of intentional conduct by a taxpayer, but relief from criminal prosecution will be offered for every successful disclosure.) A taxpayer is also not held to a standard of perfection. It is true a taxpayer must make reasonable efforts to confirm previously inaccurate, incomplete or unreported information to the CRA. The CRA is entitled to ask for additional information and documents to review a taxpayer’s application, but will not do so in every case. Finally, the information disclosed to the CRA is never automatically referred to law enforcement authorities. If a taxpayer successfully obtains relief under the CRA’s VDP, the only way for law enforcement authorities to obtain the documents and information submitted to the CRA would be by obtaining a warrant from a Canadian court. The threshold to obtain that warrant is high, and the onus is on law enforcement to justify it. The CRA’s VDP succeeds in part because, while it does not guarantee relief from prosecution in all cases, a taxpayer applying in good faith will not face increased skepticism or scrutiny from the CRA simply because of the source of funds, or nature of income being earned (e.g. income from the sale of cryptocurrencies).

In contrast, the Israeli Tax Authority’s pilot program completely failed to address these concerns in a way that would reassure an average taxpayer. The program guaranteed from the outset that any information would be automatically shared with law enforcement authorities. It also guaranteed that, simply by having filed an application, family members of the taxpayer could also be subject to an investigation. Average cryptocurrency users in Israel already face intense skepticism from other Israeli authorities and banks. While Israel has become increasingly aggressive in investigating money laundering and terrorist financing activities since 2000, and with good cause, the success of any voluntary disclosure program requires balancing policy interests with the concerns of average taxpayers. It should come as absolutely no surprise, then, that average Israeli taxpayers were unwilling to participate in a program that was openly willing to invite an investigation into their affairs by trying to correct their tax affairs.

Israeli taxpayers can only hope that, as the Israeli Tax Authority re-visits the program for future implementation, it considers how to better balance these policy considerations. There are no doubt many Israeli taxpayers who have found themselves involved in cryptocurrency, for perfectly legitimate purposes, and who wish to remain compliant with tax law, but who were understandably unwilling to take the first step to do so under the Israeli Tax Authority’s previous policy. And if the Israeli Tax Authority wants to implement a permanent policy, it might be willing to take inspiration from the CRA’s own VDP.

Pro Tax Tip: The CRA is Expanding its Resources to Audit Cryptocurrency Non-Compliance. Get Ahead of the Curve, to Avoid Penalties, Interest

In recent years, Canada has taken increasingly aggressive steps to tackle tax non-compliance in the cryptocurrency space. The CRA has continued to file lawsuits against cryptocurrency exchanges like Coinsquare to obtain information on exchange users for further tax audits. In 2018, the CRA entered into an international coalition with the Internal Revenue Service of the U.S., and the tax authorities of the U.K., Netherlands, and Australia, for exchange of information on cryptocurrency users worldwide. In 2024, the Canadian Federal Government announced further measures to require Canadian taxpayers, cryptocurrency exchange, to report on transfers and exchanges of crypto-assets (for implementation of the OECD’s Crypto-Asset Reporting Framework, or “CARF”). And in March 2024, the CRA began to leverage this information by issuing “intent to audit” letters to Canadian taxpayers, providing a grace period for taxpayers to declare any previously-unreported cryptocurrency-related income in exchange for penalty and interest relief under the VDP.

As a result, the likelihood that cryptocurrency users in Canada will be subject to a tax audit continues to increase. To make matters worse, the tax implications of cryptocurrency activities are still not well-understood by Canadian taxpayers, or even by the CRA itself. To ensure you are compliant with your income-tax obligations under Canada’s Income Tax Act, and any GST/HST obligations under Canada’s Excise Tax Act, you should engage an expert Canadian tax lawyer to perform a review of your cryptocurrency affairs. A lawyer’s communications with you, including any written opinions on the tax implications of your cryptocurrency activities, are protected by solicitor-client privilege and exempt from seizure by the CRA in the case of an audit, unlike communications with an accountant or other professionals. That Canadian tax lawyer can then advise on how to best make use of the CRA’s VDP if you are non-compliant, rather than waiting for the CRA to take the first step.

Our knowledgeable Canadian crypto-tax lawyers have assisted numerous Canadian cryptocurrency traders, cryptocurrency investors, and cryptocurrency miners with correcting their tax affairs under the VDP, saving them millions of dollars in potential penalties and from criminal tax-evasion charges. If you are concerned about your tax compliance obligations related to your cryptocurrency affairs, we encourage you to contact our office to discuss your affairs with one of our top Canadian tax lawyers.

FAQs:

Is income from illegal activities taxable?

Yes (although certain deductions for expenses incurred to earn income from illegal activities may not be deductible). The CRA is not generally concerned with how a taxpayer earns income, or the nature of any business conducted, but whether any income earned was reported as required by the Income Tax Act. As a result, income from criminal activities is reportable, and ought to be reported.

Can evidence obtained from a CRA tax audit or successful Voluntary Disclosure Application be used by the CRA against me for criminal prosecution?

Potentially. Under subsection 231.2 of the Income Tax Act, the CRA wields significant authority to require taxpayers and third parties to disclose documents and information during a civil audit. If the CRA’s primary purpose for a tax audit shifts toward a criminal or quasi-criminal investigation, then a taxpayer’s rights under the Charter of Rights and Freedoms, and common law rights may protect against an unfair investigation. Where information that implicates a taxpayer’s involvement in criminal activity was validly obtained as part of a civil audit, that evidence may be admissible as part of a criminal case, including a tax evasion case. But under the CRA’s Voluntary Disclosures Program, if a taxpayer proactively discloses tax non-compliance to the CRA before an audit is initiated, and the criteria for relief are satisfied, the CRA may exempt that taxpayer from criminal prosecution for tax evasion.

I am a dual Canadian and Israeli citizen and have carried out crypto transactions. What are my Canadian and Israeli tax obligations?

The tax obligations of a Canadian-Israeli dual citizen engaged in crypto will depend on many factors, including individual’s “tax residence” and where those activities were conducted. First, an individual’s “tax residence” is distinct from citizenship or nationality. Tax residence is a legal question, and there are a number of rules which bear on tax residence in Canada specifically, including the “factual residence” (i.e. common-law residence) test, the “deemed residence” (i.e. 183-day rule) test, and the deemed non-residence test and terms of the Canada-Israeli Tax Treaty which work to resolve cases of dual tax residence. Second, and regardless of tax residence, Canada and Israel might tax that income differently if business is being carried on in either jurisdiction. Article 7 of the Canada-Israeli Tax Treaty concerning permanent establishments might also override Canada’s and Israel’s domestic tax rules concerning business activities. It is recommended to consult with one of our qualified Canadian crypto tax lawyers to verify your tax compliance obligations in Canada if you are involved in crypto.

Disclaimer: This article just provides broad information. It is only up to date as of the posting date. It has not been updated and may be out of date. It does not give legal advice and should not be relied on. Every tax scenario is unique to its circumstances and will differ from the instances described in the article. If you have specific legal questions, you should seek the advice of a Canadian tax lawyer.