A tax ruling has been published recently on transfer of shares of an Israeli company as a gift to a relative, before being sold by that relative. The tax ruling raises several interesting issues in connection with determining the original price and the date of purchase, eligibility of new immigrants for exemption and a step-up arrangement for receipt of a gift from a foreign resident.
A brief summary of the case: A foreign resident (“the foreign father”) holding shares of an Israeli company (purchased by him in 2012) wishes to transfer them as a gift to his son, an Israeli resident (“the Israeli son”) with “new immigrant” status (as of 2014); the Israeli son will subsequently sell the shares. According to tax law in Israel, as a rule, gifts to family members are not taxable (the recipient enters the shoes of the bequeather); furthermore, foreign residents are exempt from capital gains tax when selling shares of an Israeli company; in addition, new immigrants are exempt from capital gains tax when selling shares of an Israeli company if purchased before immigration to Israel, for the duration of the benefits period (10 years). In the facts of the case it is indeed noted that were the foreign father to sell the shares to the Israeli son, he would be exempt from capital gains tax; however, he would be liable to tax in his country of residence.
Tax Authority’s decision: The Tax Authority analyzes the case and makes its decision as follows:
First, the transfer of shares as a gift is indeed exempt from tax. According to day of purchase and original price as defined in the Ordinance, the Israeli son “enters the shoes” of the foreign father; thus, the date of purchase of the shares by him is 2012, and the original price is what they cost the Israeli father.
In this case, since the Israeli son has entered the shoes of the foreign father, he is the one who “purchased” the shares in 2012 (determining the day of purchase in his matter) when he was a foreign resident;
thus, supposedly, he is entitled exemption when selling the shares. However, the law denies exemption when the sold asset is given to the immigrant as an exempt gift; thus, exemption is denied when the shares are sold by the Israeli son. We shall now clarify that the stated qualification is intended to deal with situations in which an Israeli resident (not a new immigrant) owning a foreign asset transfers the asset as an exempt gift to a relative who is a new immigrant, and the latter sells the asset with exemption; the taxable profit is thus “laundered” and classified as exempt profit in the hands of the seller. The case under discussion is different from this aspect, since the profit accumulated by the original owner (the foreign father) would have been tax exempt in any case, had the shares been sold by him.
To summarize, after rejecting the request for exemption (when sold by the Israeli son), it is decided that the original price will still by calculated according to the “entered his shoes” principle; thus, when in the hands of the Israeli son, the entire accumulated profit (which would have been exempt if sold directly by the foreign father) will be taxable.
Associated issues: On the face of things, it appears that the request itself and the way it is presented are somewhat disturbing; hence, the final conclusion may have been inevitable. Nevertheless, there are substantial issues which need to be addressed, and which could (under certain conditions) have even changed the final position determined:
Denial of exemption is based on the gift being a tax-exempt gift among family members. In our opinion, the shares could have been transferred to the Israeli son free of charge (an event still considered a sale with respect to the Tax Ordinance) without asking to apply the exemption to the foreign father rather the fixed exemption on capital gains for foreign residents.
Later on, the original price and date of purchase by the Israeli son should be clarified. In principle, the accepted general assumption is that anyone receiving an asset, the transfer of which was tax-exempt is entering the shoes of the giver with regard to the original price and day of purchase, according to the ‘principle of continuity’, and vice versa. In addition, it is common practice that the day of purchase and original price are interconnected; thus, if a historic day of purchase is determined then the original price will be historic too; and if a new date of purchase is determined then the original price will be the value on that date. In the case at hand, according to the definitions in the Ordinance, these things are not clear and one may even arrive at different conclusions.
If so, the result will be that if a historic date of purchase and original price have been determined, then sale of the shares by the Israeli son will be tax exempt, since he was a foreign resident when “purchasing” the shares, and the qualification of an asset received as a gift among relatives does not apply anyway. If a new date of purchase and an original price have been determined, according to value on date of transfer to son, then no exemption from capital gains tax will apply; however, capital gains will be smaller and constitute only the increase in value from the day the shares are received until their sale.
Another issue that arises is connected with step-up arrangements provided by the Tax Authority, with regard to gifts from a foreign resident. If applied in this case too, the increase in value until the date of the gift would have been exempt from tax in Israel.
However, the Tax Authority does not grant such arrangement with respect to assets in Israel. The question is, why not? The aim of a set-up arrangement is to prevent taxation of an asset’s increase in value during the period in which it was not taxable in Israel; this is true in the case of an Israeli asset whose owner, had he sold it, would have been exempt from tax. However, there is a difference between the two types of assets, since an increase in value of a foreign asset owned by a foreign resident is not at all taxable in Israel, whereas an increase in value of an Israeli asset (under the circumstances described) is subject to tax in Israel but exempt according to a specific clause.
Nevertheless, the difference between them is not substantial rather semantic only.
It may be that the final decision was based on the assumption (or knowledge) that the move the parties wished to make was designed to avoid being taxed in a foreign country, while exploiting the provisions of Israeli law; however, such a move can also be made in the case of an asset outside of Israel. In such as case, the Tax Authority allows an unconditional step-up arrangement with regard to taxing the gift giver abroad. Subsequently, should the very mention of the giver being liable for tax in his country of residence, had he sold the asset, have implications for the final conclusion? In other words, if capital gains tax did not apply to the foreign father in his country of residence at the time he sold the asset, would the decision have been different?
To conclude, before making such moves or other similar ones, it is advisable to consult and examine all applicable aspects of tax, in Israel and abroad; it may be that different results can be achieved, as a result of changing the moves themselves or changing the claims raised.