New Israeli Court Ruling on Artificial Transactions – Introduction
In a recent ruling, the Israeli court addressed claims by the Netanya tax assessor regarding the restructuring of Shalam Packaging Products Group.
The assessor argued that the group’s restructuring was conducted solely to reduce tax liabilities by offsetting business losses against a capital gain from insurance payouts following a fire at one of their plants.
Background of the Restructuring
Shalam Packaging Products (1998) Ltd, the parent company, manufactures and markets plastic packaging products.
It owns several subsidiaries, including Shalam Packaging Solutions Ltd., which operated an industrial plant in Yakum.
The parent company acquired 100% of the subsidiary’s shares between 2008 and 2013, during which the subsidiary incurred business losses totaling about ILS 54 million.
In January 2014, the parent company filed a notice of restructuring with the tax assessor, transferring assets to the subsidiary under Section 104A of the Income Tax Ordinance, in exchange for shares allotted to the parent company.
Subsequently, the subsidiary transferred operations from its Yakum plant to the parent company’s plant in Caesarea.
Dispute with the Tax Assessor
In June 2014, a fire at the Caesarea plant led to insurance payouts totaling ILS 155 million.
The group reported capital gains from these payouts and offset significant business losses against this income.
However, the tax assessor claimed the restructuring was a scheme to improperly reduce tax liabilities, labeling it as an artificial transaction.
The assessor issued a tax assessment charge, disallowing the loss offset.
The assessor also contested the classification of ILS 49 million in capital notes from the subsidiary’s previous owner, Kibbutz Yakum, as perpetual notes.
The assessor argued these were regular liabilities and should be treated as such for tax purposes, requiring the income from debt forgiveness to be offset against the business loss.
Court Ruling
The court ruled in favor of Shalam Packaging Products Group, rejecting the tax assessor’s claims on several grounds:
- Attribution of Insurance Payouts: The court allowed the subsidiary to offset ILS 37 million from business losses against the capital gain from insurance payouts. The decision was based on an objective assessment by an external appraiser.
- Offsetting Business Losses: Citing the Supreme Court’s Ben Ari case, the court ruled that shareholders could offset business losses based on their holding ratio at the time the losses were incurred. The parent company, holding 50% of the subsidiary’s shares since 2009, was entitled to offset losses proportionally.
- Artificial Transaction Claim: The court rejected the claim of an artificial transaction, determining that the restructuring had substantial commercial purposes. The restructuring aimed to leverage synergies between related businesses, not solely to achieve tax benefits. The court emphasized evaluating the legitimacy of tax planning by balancing various interests and highlighted genuine business conduct over years.
- Income from Capital Note Forgiveness: The court ruled that the capital notes were perpetual and reclassified as such since 2008. Therefore, Section 3(b) of the Income Tax Ordinance, dealing with debt forgiveness, did not apply. The parent company ensured the notes were not callable, aligning with their commercial interests.
New Israeli Court Ruling on Artificial Transactions – Conclusion
This ruling underscores the importance of commercial substance in tax planning and restructuring activities.
It confirms that tax authorities must consider the genuine business purposes behind transactions, rather than solely focusing on potential tax benefits.
The decision provides clarity on how business losses can be offset against capital gains and reinforces the distinction between legitimate tax planning and artificial transactions.
Final thoughts
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