International taxation - Agency, implied trust, and implied partnership

On December 2016 the Tel Aviv – Yafo District Court (tax appeal 25689-02-13) gave a ruling on the matter of Roni Lerner (“the Appellant”) with regard to classification of relations between a foreign company and its registered shareholders, whether as a trust or as formal relations between a company and its owners. Within this ruling lie interesting issues, which could be relevant as far as many common investment structures are concerned.
The details of the case are somewhat complex, and are detailed in brief as follows: Several shareholders incorporated through a company incorporated for this purpose (referred to as an SPC – Special Purpose Company) i.e., holding shares in the main company which had business activity and was subsequently issued to the public (“the Company”). The Appellant held shares in the SPC through another foreign company owned by him (we shall note briefly that it was agreed that the other foreign company served as a trustee for him).
A procedure was conducted between the shareholders and the Tax Authority for receipt of preliminary approval, determining that transfer [by the SPC] of Company shares to shareholders shall constitute sale; however, remuneration and taxation will be deferred until the actual sale of the said shares. The details of the agreement are not too clear from the ruling, since, if indeed this is sale then the tax event is determined on the SPC level, and the very distribution of the asset to the final shareholder may constitute a dividend in his hands. Thus, in the assessment issued by the income tax assessor to the Appellant, it was determined that the very transfer of company shares to his possession does indeed constitute a dividend (it appears that this assessment contradicts the principles of the preliminary approval but we will not discuss this issue).

The court was required to classify the relations between the shareholders and the SPC for the purpose of analyzing the tax events involved with the transfer of shares. In the final analysis, the court has determined that this is a trust in which Company shares are held for the shareholders, while the SPC and its formal manager serve as a trustee for it. This, despite the fact that the preliminary approval received from the Tax Authority with consent of the shareholders, including the Appellant, referred to the SPC as a company for all intents and purposes.

The ruling determines or repeats several principles on this matter, for example:

• That the formal substance of relations shall not affect the classification for tax purposes, which follows the economic substance of the transaction or engagement, even if an agreement is made with the Tax Authority indicating a different substance of relations; and in the words of the court:
  “These shareholders may have considerations of their own for acting as they have acted, and they may have acted out of caution”;
• That an arrangement according to which an SPC is established for the purpose of common, passive holding of shares, serving as a conduit only for the shareholders, constitutes an implied trust arrangement, in accordance with the parties’ intention of actually engaging in this type of agreement; it should be noted that the existence and meaning of “implied trust” involves tax advantages or risks.
• That the very fact that the appellant reported his holdings in SPC shares (apparently as part of Form 150 – a form in which Israeli residents are required to report holdings in a foreign resident company) and not in Company shares, does not disprove the claim that the SPC constitutes a trust for holding Company shares;

The ruling also notes that trust agreements (fiduciary agreements) between the parties have been signed at different times. According to our understanding, this type of relationship usually shelters under an agency type rather than a trust type of arrangement, although at times only a thin line separates trust arrangements from agency arrangements. The taxation aspects of the two types of arrangements will not necessarily be different; however, the trust chapter of the Israeli Tax Ordinance does not apply at all to an agency type arrangement; hence, no special reporting obligations are required of the trustee, the settlor or the beneficiary, according to the matter.
In light of the aforementioned, in those cases in which a particular corporative structure is formed for the purpose of investment in a substantive company, the substance of the relations and agreements should be examined. It may very well be that it is a trust or agency type of arrangement, despite the formal guise given it. It should be noted that the distinction is important in light of the possibility of certain gaps between the two approaches, implications on the matter of crediting foreign taxes, and implications with regard to control and management when the agent is a foreign corporation.