Failed tax planning for selling shares

Acardinal rule of tax planning is to do it in good time. A second rule is not to rely on the Israel Tax Authority (ITA) to save the day. All this was proven in a recent ITA anonymous ruling that was issued without the taxpayer’s agreement.

The facts of the ruling

Mr. X (“Dad”) is a foreign resident who holds shares in an Israeli private company. Those shares were acquired in 2012 and 2013.

Dad’s son (“Son”) lives in Israel after first becoming an Israeli resident in 2014. Dad wanted to make a tax-exempt gift of the shares to Son. Subsequently, Son intended to sell the shares. According to the ruling, if Dad were to sell the shares in the Israeli company, he may be exempt from Israeli capital-gains tax (CGT) but be subject to tax in his home country.

The ruling decision

In the ruling decision, the ITA refused to grant a CGT exemption to Son if he sells shares gifted to him in the Israeli company.

Olim generally enjoy a 10-year Israeli tax holiday on foreign-source income and capital gains.

In the case of a sale of shares in an Israeli resident company (an Israeli-source gain), the 10-year tax holiday does not apply at all. Instead, upon a sale of Israeli shares and other Israeli securities, Israel grants a CGT exemption to foreign-resident investors and to new or senior returning residents (who lived abroad at least 10 years) if they acquired the Israeli shares or securities before they became Israeli residents.

In this case, there is a catch-22 situation. If Son acquired the Israeli shares by way of gift from Dad, Dad’s acquisition date applies, which was before Son became an Israeli resident. But Son still does not get an Israeli CGT exemption for selling Israeli shares he received by way of gift, according to another section of the tax code. Instead, Son remains liable to Israeli CGT on the sale price minus Dad’s cost.

To some up, instead of no tax, the ruling facilitates Israeli CGT on the full gain to both Dad and Son.

Comments

This result was predictable and avoidable. Aside from the two cardinal tax-planning rules above, there is a third unwritten rule: The ITA will never knowingly help a taxpayer defeat a foreign tax authority. So the ruling result is no surprise. So what can be done now? One possibility might be for Dad to consider making aliya, then sell his shares in the Israeli company. Assuming Dad bought the shares on arm’s-length terms from an unrelated party before becoming an Israeli resident, he should be exempt from Israeli capital-gains tax thereon.

It would also be necessary to check whether any foreign tax applies (we don’t know which was the other country in this case).

For example, the United States taxes its citizens even if they move to Israel, and Canada may impose or collect its departure tax on emigrants from Canada. UK olim must get the timing right and not return to live in the UK for a period of five to six UK tax years, depending on what gets enacted after the UK election.

As an alternative possibility, Son should consider applying for a “step-up” of the cost of the Israeli shares to their market value as of the date Dad gives Son those shares. This is done on Tax Form 905 and is granted by the ITA on a discretionary basis. There is no mention of any “step-up” application in the above ruling.

To sum up, do your tax-planning homework in advance – not at the last minute.

As always, consult experienced tax advisers in each country at an early stage in specific cases.

leon@hcat.co

Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.