Tax Alert No. 32 - 19.12.2018

The Israeli Tax Authority has recently published a new green path, the subject matter of which is an application in advance for the transfer of all of the rights in a company that is resident in Israel to a company that is not resident in Israel with which the State of Israel has a tax treaty, in consideration for the allocation of shares – a process that is generally called – “Corporate inversion“.
General background
The green path is an abbreviated, expedited path for the making of tax decisions on applications in advance that have been submitted. This is not an automatic approval of a tax arrangement – in any event the application has to be passed to the Professional Department which is supposed to decide positively to approve the proposed tax arrangement within a short period of time, which is predefined in the Ordinance.
Corporate inversion is a name for the arrangement of activity that causes a change in the structure of the holdings in companies, such as in this case, in which the shareholders of a company that is resident in Israel sets up a new foreign company (hereinafter: “The absorbing company” or “The foreign company“) transfer all of their rights in the company resident in Israel to it (hereinafter: “the transferred company” or “The company“) in consideration for the allocation of shares in the absorbing company. The main reasons for such a process are: entry into new markets, the recruitment of foreign investors, issuance considerations and etcetera. A corporate inversion is deemed to be a tax event at the level of the shareholders of the transferred company as a result of the sale of their rights in it. However, insofar as the condition is met, it will be possible to receive a deferral of the tax event until the time of the sale of the rights in the absorbing company and in this special case, even if the absorbing company is a foreign company. However, we will mention that transfers of assets (including shares in an Israeli company) to such a foreign company are only possible with the approval of the Director of the Israeli Tax Authority.
In the distant past, the Tax Authority published a tax ruling under agreement, which dealt with a similar case. Furthermore, changes have occurred in the legislation in the event of a structural change and ancillary reliefs. The new green path, which were we are discussion in this bulletin, has been published within the spirit of these matters.
:The main conditions
 A number of conditions have been published within the context of the green path, which if met, such an application is to be submitted on the green path for the making of a tax decision. Inter alia, the following conditions have been published:
 The transferred company has been incorporated after 1.1.2018.
 The absorbing company is not a transparent entity (in its country of residence), it is a new company that has been incorporated for the purpose of the structural change and it has not assets or liabilities whatsoever as at the time of the structural change.
 The application is submitted within a period of three months preceding the structural change.
 There is no consideration in money or in money’s worth in respect of the transfer of the shares.
 The tax rate for companies in the foreign company’s country of residence exceeds 15% and there is taxation on passive profits in companies outside of that country, which are controlled by the foreign company (CFC rules).
 The rate of tax to be deducted at source, which is set in the treaty between the two countries on the distribution of dividend from the company to a foreign company is at least 10%.
 There is no transfer of tangible assets, activity and/or intangible assets in the company being transferred outside of Israel.
The trustee and the tax arrangement
It has been determined that the timing of the structural change will be the time of the transfer of the rights actually being transferred and in the event that the transfer of the rights is not executed within 90 days from the time of the signing of the tax ruling, the ruling will be cancelled unless an extension has been provided in writing. Furthermore, it is agreed that the rights that are allocated and the eights that are transferred by the trustee who will be responsible to the Tax Authority for the payment of the full amount of the tax deriving from the transfer of the rights, from the conditions of the tax ruling and from the provisions of any law, in respect of the rights that are allocated and in respect of the rights that are transferred, which will be the case until approval is received from the Assessing Officer.
The distribution of a dividend and capital gains on the sale of shares
When a dividend is distributed from the company to a foreign company, which is sourced in profits that have arisen until the end of a period of two years following the end of the tax year in which the structural change is made (hereinafter: “The period”), the foreign company will be chargeable at the rate of 30% in Israel. When a distribution is made out of profits that have been made after the period, the foreign company will be chargeable with tax in Israel on a dividend in accordance with the provision of the treaty. Furthermore, an arrangement has been determined for a credit for the tax deducted at source as aforesaid, at the time of the distribution of the dividend from the foreign company to the holders of the rights.
The sale of the shares being transferred by the foreign company is to be made pro-rata and will be viewed as if they had been sold by a company that is resident in Israel (in accordance with the “standing in the place of” principle, which is chargeable with capital gains tax in Israel without a right of deduction, offset, exemption or credit (including from foreign tax), and the sale of the shares that are allocated in the absorbing company will be chargeable with tax and done in accordance with the provisions of the Israel Tax Ordinance.
In summary, this is an outline for a tax ruling on a green path, which enables a structural change in which the absorbing company is a foreign company that is resident in a treaty country. However, the numerous and stringent conditions may not be appropriate for every such structural change and accordingly consideration should be given to compliance with these conditions prior to the execution of the process.

The chapter on trusts in the Income Tax Ordinance includes the following provision to avoid tax planning: A company that has assets, creates a trust, the beneficiaries in which are the controlling interests in the company, the company transfers assets to the trust, which will transfer them to those same controlling interests in the future (the beneficiaries in the trust), whilst raising claims regarding the absence of a tax charge.
Such planning might have been realized in light of the fact that most of the cases of the creation of a trust and the transfer of assets to it do not constitute a tax event and that is also the case in respect of most of the distributions of assets from trusts to beneficiaries. We have intentionally not related to “corners” and exceptions to the said principles.
The law determines that in a case in which a company transfers assets to a trustee, two events will occur:

1. The company will be deemed to have transferred the assets as if it had sold them – and then a capital gain may arise in the hands of the company.

2.  The asset that has been settled in the trust is deemed to have been the distribution of a dividend to the individual shareholders (directly or indirectly) in that company.

   :Clarifications and tax implications

   • Relating to a company – It should be noted that the said provision related to every “body of persons” and not just to a company. This term is much broader and therefore there are significances for the application of the provision.

   • Distinction between an “agency” and a trust – a distinction must be made between a situation in which a company transfers assets to a third party in order for it to hold those assets for it, this situation generally does not create a “trust” since the asset, the rights and the obligations therein, the revenues and etcetera belong to the owners. In this case, what is under discussion is an “agency” (or fiduciary). In such a situation, it should be noted that the agreement must reflect the existence of that agency and it is also appropriate that its heading should be “agency agreement” and not “trust agreement”.

   • A sale to a trust other than at market price – we would say to a smart planner, who seeks to by-pass the provision by executing a “sale” of the asset to a trust, that the sale must be made at the market price! A sale other than at market price may be deemed to be a “contribution” into a trust to which the provision in the preceding paragraph applies, which is in light of a possible interpretation, pursuant to which the difference between the market price and the actual selling price meets the definition of a “contribution”.

   • What is an asset? – We would emphasize that “an asset” is any asset within the broad definition of that term, including real estate rights in Israel.

   • The new cost price of the asset – the price that has been set as the selling price, which is equivalent to the amount of the dividend that has been determined by the shareholders and it is appropriate that is should constitute the “cost price” in the hands of the those shareholders.

   • “Tax mishaps” – over the years, we have encountered incorrect application, such as a case in which an Israeli company creates a significant agency arrangement on the transfer of an asset to a separate company, but has reported, in good faith and without having conducted an in-depth exanimation of the situation, on the creation of the arrangement as the creation of a trust, including the filling in and submission of the designated forms that have been published in relation to trusts (which is something that has resulted in the opening of a trust file and etcetera).

We would like to remind our readers that a voluntary disclosure process that enables the submission of anonymous applications will end at the end of the year 2018. The significance of this is that it is sufficient that someone has submitted his application by December 31, 2018, even if the handling of the application continues afterwards. Applications that are submitted as from January 2019 for voluntary disclosure will be required to submit an application that includes the taxpayer’s details!
It is clear that the situation of a taxpayer for whom an anonymous application is submitted is better, since he has the possibility of assessing the tax results and the agreement that will be signed with the Tax Authority before his details are exposed, that taxpayer also has the possibility of “retracting” and withdrawing the application and experience shows that within the framework of the anonymous process, the preparedness to reach agreements is greater.
In respect of crypto investors – a lot has been spoken about the tax authority’s position is that Bitcoin, Ethereum and the other crypto currencies constitute “an asset” and accordingly their sale is taxable as-capital gains, this position also applies to exchanges between crypto currencies and tokens – which constitute tax events. In recent months, we have encountered numerous clients who have received approaches from the Tax Authority and a demand for the submission of annual reports for recent years. Clients that received such demands are generally found on lists that the Tax Authority holds and it is known that they have purchased or sold crypto currencies. This information generally comes from files of central players in the industry who have been checked and it has been found that they sold currencies to those clients and the Tax Authority also has other ways to arrive at that information.
We should mention that a crypto investor who receives a demand from the Tax Authority – is not entitled to refer to a voluntary disclosure process, which is because the Tax Authority “has begun an examination”, prior to the submission of the application, and this is one of the conditions for the submission of the application. Solutions to this problem can be found by way of submitting reports to the Authority as requested by the Authority and reaching an arrangement whilst holding negotiations in respect of the tax implications. We would mention on this subject that we are aware of the existence of pending proceedings on the subject in the Courts, and it is our assessment that it will not be long until a ruling is handed down as to whether or not the crypto currencies are an “asset”.
At this opportunity, we are calling on the Tax Authority to publish a clear position on the issue of the crypto currency alternatives – this is an issue that constitutes the core of the problem in the arrangement of the field and will present as an example a Bitcoin, which was purchased at a price of $200, and which was exchanged in the last quarter of 2017 in consideration for Ethereum coins, where the value of the Bitcoin was $18,000 – in accordance with the Authority’s approach, the very fact of the exchange between the coins constitutes “a sale” of the Bitcoin coin (with a profit of $17,800) , which is chargeable with capital gains tax. A statement was published in the press recently that a senior person in the Tax Authority has given instructions for relief on the subject of a FIFO or a LIFO calculation, however this relief will not solve the fact that already one year after the last quarter of 2017, the Bitcoin (and the other tokens) have not reached the price levels that they had towards the end of the year 2017 – a period in which the crypto investors were “celebrating” and in retrospect , these were “celebrations on paper”, most of which have not been realized into “Fiat” money.

A ruling was recently published by the Supreme Court, in the Rafi Amit case, which approved the ruling that had been handed down by the District Court. The ruling dealt with two central issues – the first of which was the matter of residency for tax purposes, which we will discuss in this bulletin and the second of which is the issue of the classification of revenues from the winnings in poker games.
The ruling in the district court determined that the appellant is deemed to be resident in Israel in the 2007 tax year, which is the subject matter of the appeal, even though he was only there for 30 days, which was primarily because of his various connections to Israel (including an active bank account in which the monies from the winnings were deposited), the fact that he stayed for many days in the years before and after the tax year that is the subject of the appeal and also because of the fact that he did not determine residency in any other place in the world. We would mention on this matter that the “substantial staying” assumption for the determination of residency in Israel (which is 183 or more days in the tax year, or alternatively a stay of 30 days in the tax year and 425 days cumulatively in the tax year and in the preceding two years), is a positive assumption, in other words, if met, the assumption is that the assessee is a resident of Israel (and a burden of proof will be imposed upon him to prove otherwise), whereas if they are not met, there is no reverse assumption in accordance with which he is assumed to be a foreign resident. Furthermore, in the circumstances of the case, the existence of an active bank account in Israel may constitute a relevant and significant index in the determination of residency (a criterion the importance of which it is usual to make little of in practice).
As mentioned above, the ruling in the Supreme Court confirms the determination by the District Court on the subject of residency. The following is a brief description of the significant insights (which some may call worrying) on the subject of residency:

1. The issue of the absence of general residency, has also been brought up in the ruling by the Supreme Court, which on the one hand did not rule out the possibility of the existence of this situation (that an individual will not be a resident in any country) and it mentions that “Attention is drawn to the fact that the Ordinance does not determine that a person must be resident in any country whatsoever. However the lights are now shining on the question of whether he is a resident of Israel“, however, this is a parameter that is absolutely relevant in the examination of the existence of Israel residency, and as Judge Hendel stated: “an approach to another country in which the assessee claims that he was resident in the tax year, is a characteristic that is relevant within the framework of the overall examination of the center of his life”.

2. An interesting and far-reaching statement was made by the Judge on the subject of “retention of Israeli residency” as the default choice. According to him: “Whoever is a citizen and resident of Israel – and especially whoever was born and grew up in Israel – and has gone abroad, the starting point is that he remains a resident of Israel, even if he stays for continuing periods of time outside of Israel“. The Judge further determines that the breaking off of residency may only occur if activities are performed evidencing a subjective intention to break off residency – such as, for example “a waiver of citizenship” and “the sale of his house and his assets in Israel“.

   In our opinion, it is appropriate and correct to examine the issue of residency separately from “the assessee’s Israeli past” and there is no room for implementing the “umbilical cord” approach, which draws back and retains the Israeli residency of someone whose origins are in Israel. The Judge’s comments that “in the current global reality, the phenomena of continuing stays outside of the country for various needs, such as for the purposes of academic studies or for work (generally in international companies) is common, and may lead to a conclusion that the moving of fiscal residency is easier in the present era since things are more accessible and more acceptable, and it should not be concluded from this that today even a long stay abroad does not break off the Israeli residency.

3. The Judge’s “recommendation” to waive the Israeli citizenship as a condition for the breaking off of residency is slightly surprising, since citizenship does not constitute a criterion in the array of the types of connections that indicate “a center of life”, pursuant to the definition of “resident” in the Income Tax Ordinance and in the tax treaties, the citizenship status is the last in a list of criteria for tests for breaking a tie. Furthermore, a recommendation to sell the house and the assets of someone who goes abroad does not fit with other rulings on the subject of residency since the existence of a house and assets constitute a single criterion out of many criteria in the center of life test, all the more so when they were bought by the assessee a very long time before he left Israel. We would mention on this matter that the “fixed home” test, which is implemented in the tax treaties, it is only required that this house will not be available and adapted for the assessee’s residence and its sale is not be required of course. It would seem that the importance of the subjective test (the assessee’s intention) receives extra importance in the judgment, and this test, the status of which has been reduced and restricted in the latest rulings, has come back to life. The question that needs to be asked, of course, will be whether the same criteria and interpretation is to be used for someone who comes to Israel for a period of several years for a defined objective without asking for Israeli citizenship and without him having sold his assets in the foreign country from which he came, will that individual then be considered to be a foreign resident?

4. At the end of the day, it would seem that the legal conclusion in accordance with which the appellant remains a resident of Israel in the tax year, rests to a considerable degree on the absence of the status of residency in another country, and in recent years, the correct advice that has been given to someone wishing to break off their Israeli residency is first of all to determine fiscal residency in another place and not to retain a lack of residency. Confirmation of residency from the foreign country is required, for example, within the framework of the declaration of Israeli residency that is submitted in certain cases in relation to someone who claims that he is a foreign resident. This statement, in respect of the substance of the residency in another country test, constitutes a continuation of a trend that has found expression in other rulings as well. We would mention that residency in another country has decisive importance where the individual is resident in a treaty country and he claims foreign residency in Israel not only under the force of the provisions of the Ordinance and also under the force of the tie-breakers in a treaty.