Recognition of startup and business establishment expenses

According to the basic principle of tax law, tax is paid only on profit. Profit is calculated based on total income for a given year, minus total expenses for that year. The basic rule regarding the deductibility of expenses for income tax purposes states that any expense incurred in the production of income is deductible, unless the deduction of expenses is explicitly limited or disallowed.

The basic conditions for recognizing expenses for tax purposes are:

• The expenses were incurred for the production of taxable income. – That is, these are not private expenses, but expenses for the purpose of generating taxable income.
• The expenses were incurred in the tax year in which the income was earned. That is, only the portion of the total expense for which taxable income was generated in the tax year will be recognized.
• The expenses were incurred solely for the purpose of generating income In other words, these are not mixed expenses, some of which are characteristic of expenses for generating taxable income and some of which are private, but rather expenses that are all intended solely to generate taxable income.

1. Pre-business expenses are expenses incurred by the taxpayer before they began business activities and are clear examples of capital expenditures. Since the taxpayer had not yet begun business activities, it is clear that the expenses were not intended for income generation in that tax year, as their purpose is to prepare infrastructure for future income generation.
2. As a general rule, expenses incurred for the establishment of the business will be considered capital expenditures and are not deductible as current expenses. Expenses paid during a period that began before the commencement of operations and ended after the commencement of operations will be prorated between the periods.
3. Namely, expenses attributed to the period before the commencement of operations, i.e., during the business's formative period, will not be recognized as current expenses, but rather as capital expenditures, whereas expenses relating to the period after the commencement of business operations will be recognized as deductible expenses.
4. The courts have also ruled that when business activity began, business expenses will be deductible even if no income has yet been generated.
5. So, what will the taxpayer do with these expenses? The classic answer was that if he wishes to deduct the pre-business expenses at some point from his income, he must try to load them onto a depreciable asset or another asset whose production or acquisition costs will be deductible in the future. If, for example, the expenses could be linked to the construction of a future building to be used by the business, the expenses would be reduced over the depreciation period of the building in accordance with the applicable depreciation rate. When the expenses cannot be loaded onto a depreciable asset, we will at least try to load them onto a non-depreciable capital asset that is expected to be sold one day.
6. In the circumstances above, for a business in its early stages, which has not yet begun its business operations and incurs significant expenses as part of establishing its new business, we recommend consulting with an expert to receive a business and tax plan that suits the business's needs and future.

Reader question:
Is the sale of a residential apartment by a company, which used the apartment for its office operations, subject to VAT?
Answer:
The VAT Law imposes liability on a transaction as defined in the VAT Law, which includes, among other things, the sale of an asset by a dealer in the course of their business, including the sale of equipment. According to the various interpretations and judicial tests relating to the definition of "transaction," it can be argued, in broad terms, that the sale of the office will not be subject to VAT due to the absence of a "business" of real estate trading, and therefore the company is also not a "dealer.".