We would like to inform you of some of the mandatory reportable positions that were published by the Israel Tax Authority (the “ITA”). This update focuses on some of the positions, and does not constitute an exhaustive list of all the new positions that were recently published. For the complete list of the mandatory reportable positions (in Hebrew) click here.
As a reminder, according to Israeli tax law, the ITA may publish each year a list of positions that if taken by taxpayers, must be reported, to the extent that taking the position creates a tax advantage greater than 5 million NIS in the tax year in which the position was taken, or above 10 million NIS during a maximum of four tax years. Failure to report a position that is legally reportable, is regarded as a failure to file a tax return that was required to be filed by law, and may have both civil and criminal consequences. It is important to emphasize that there is no impediment to taking an approach that contradicts the ITA's positions (even more so when some of the positions contradict court rulings or the legislation itself, as will be detailed below), but care must be taken to report the contradicting position.
The list of positions is published only after the comments of the practitioners, including the Bar Association, have been received. As in previous years, our firm's representatives took a significant part in formulating the Bar Association's response to the draft list, a response that helped reduce the number of new positions published in 2019 by about one third, compared to the draft list published by the ITA.
It should be noted that the list of positions is a cumulative list, so that the new positions join those that have already been published in previous years, which also remain reportable positions in the relevant cases.
Position No. 61/2019 - Classification of Income from Distribution in Accordance with Section 303 of the Companies Law The manner of classifying a distribution from a company has significant implications for the shareholders who receive the distribution. Dividend is considered as income by individuals, and in some cases, as income for companies as well. Conversely, capital reduction is in some cases considered as a non-taxable return of investment. This position establishes as a reportable position the ITA's positions as expressed in a circular published by the ITA in 2018 (Circular No. 1/2018) which discusses the distinction between a dividend and a capital reduction. According to this position, in cases where the source of the distribution is in the profits or the gains that have grown in the company, the distribution will be classified as a dividend even if it was classified as a reduction of capital under the Companies Law, and was done after obtaining the court's approval as required in order to reduce the capital. The position states that only a distribution that is made after all the profits in the company have been distributed (including capital funds) and it has been proven that amounts were distributed out of money invested in the company in share capital and premium will be considered a reduction of capital. The position states that the following distributions will be considered dividend distributions rather than capital reductions, even if they were made after obtaining court approval as a capital reduction: (1) A distribution made from bonus-shares or other funds derived from profit capitalization; (2) A distribution carried out with the approval of a court (as a reduction of capital), for which the company explained that its repayment capacity is based on profits built-in the company's assets that will be sold following the distribution; (3) A distribution carried out with the approval of a court (as a reduction of capital), where the company has share capital and premium (or other capital funds) 3 derived from the issuance of capital in exchange for the transfer of assets to the company as part of a tax-free restructure; (4) A distribution made with the approval of a court (as a reduction of capital), originating from capital issued during the tax year in which the distribution was made or in the two preceding years; (5) A distribution not from profits resulting in a deficit in the company's equity. Position No. 62/2019 - Reverse Triangular Merger This position also reflects a position published in a circular in 2018 (Circular No. 3/2018). This position relates to the structure of the financing of merger and acquisition transactions, known as Debt Push Down, the essence of which is a merger of a designated leveraged company into a target company that survives the merger, such that following the merger the target company inherits the debt of the designated company and repays it from its owns sources. In accordance with this position, the amount of debt of the designated company transferred to the target company will be considered for Israeli tax purposes as a dividend distribution to the purchaser. The date of the dividend tax event is the date of repayment of the debt by the target company (if it is a loan from the purchaser) or the date of the purchase transaction itself (if it is a third party debt). Position No. 68/2019 – Bonus Grants Disguised as Stock Allocation This position refers to the dividend received due to shares granted under section 102 of the Income Tax Ordinance. The position reflects the position of the ITA, which parts of it were recently rejected by the District Court, as we updated you in a client update on July 7, 2019 [to view the client update click here]. The new position lists certain cases in which the granted shares would not be regarded as shares for the purpose of the capital route under section 102 of the Income Tax Ordinance, and thus a dividend received thereon will not be considered as dividend, but rather as labor income. Among other cases, the position states the following: (1) The issuance of shares which expire upon the termination of the employee's employment; (2) Issuance of shares that do not carry voting rights; 4 (3) The issuance of shares that may not receive a dividend declared to the other ordinary shares; (4) The issuance of shares that will receive a dividend subject to a decision by the board of directors to distribute to this class of shares (and not to the rest of the ordinary shares). Position No. 70/2019 - Share-Based Compensation Recorded as a Capital Transaction In accordance with this position, share-based compensation to employees of a subsidiary, which was presented in the financial statements as capital instruments grant (i.e., the expense was recorded against an equity item and not against a liability, and the amount of the expense was estimated as a function of the fair value at the grant date), will not be considered debt of the subsidiary, rather, will be considered as an equity investment by the parent company. Accordingly, if the subsidiary's accounting record of the expense was against a capital item, any payment made by the subsidiary to the parent company as a reimbursement of expenses for the equity compensation granted to its employees will be considered a dividend or a capital reduction, and not a debt repayment, such that withholding tax may apply. Therefore, in order to avoid a withholding tax issue, it is important to consider how the transaction is accounted for in the subsidiary's books, and to record the expenses against a liability to the parent company. Position No. 77/2019 - The Passive Income Condition of a Controlled Foreign Company in the Case of a Group of Companies As is well known, classifying a foreign company as a controlled foreign company (CFC) means that the profits of such company from passive income should be considered as distributed by it to its shareholders (holding over 10%), thus creating a tax liability without the shareholders actually receiving distributions. In accordance with the provisions of the tax legislation in Israel, when a foreign business company heads a group of companies, in order to determine that the subsidiaries in the group are CFCs, it must be analyzed whether most of the overall group's income is, collectively, passive. This is contrary to a situation where there is 5 no active company heading the group, in which case the classification of each foreign subsidiary must be examined on a stand-alone basis. The new position effectively repeals the said distinction and states that even in the case of a group of companies headed by a foreign active business company, each company and group member must be examined on a stand-alone basis. This position may have a significant impact on business groups, including in the use of a financing company, and therefore requires special attention. * * * In addition to the above positions, which are mainly relevant to companies, a number of positions relevant to individual taxpayers and trusts have been published as well, including the positions listed below. Positions No. 72/2019 and No. 73/2019 - The Holding Rate of a Veteran Returning Resident or First Time Israeli Resident in a CFC and a Deemed Dividend for such Shareholder (and corresponding positions, 74/2019 and 75/2019, in relation to a Foreign Personal Occupation Company - FPOC) In accordance to these positions, when examining the classification of a foreign company as a CFC (or FPOC) in the tax year in which the shareholder ended the benefited period as a first time Israeli resident or as a veteran returning resident, the holding percentage of the shareholder that ended the benefited period during the year should not be neutralized, rather, such shareholder should be treated as a resident of Israel. In addition, the deemed dividend that the resident will receive from the CFC (or FPOC), which is subject to tax, will be determined in accordance with his share of the company's earnings that accrued throughout the year and not only in accordance with his share of the profits accrued after the end of the benefited period. Position No. 78/2019 - Maximum Exemption Period of an Israeli Resident Trust, which One of Whose Creators was a First Time Resident of Israel, a Veteran Returning Resident, or a Returning Resident The position of the ITA, as expressed in this reportable position, is that the trust exemption period will end on the earliest date of which any of the settlors or of the 6 beneficiaries exemption period ends, even if some of the settlors or the beneficiaries have came to Israel at a later date. This position reflects the ITA's position that trusts cannot be divided into different parts, for example, according to the dates of immigration of the various beneficiaries. Therefore, it is advisable to consider the possibility of dividing the trusts before the end of the tax exemption period. Position No. 79/2019 - Distribution Following the Exemption Period Deriving from Profits Generated and Accrued During the Exemption Period in a Relatives Trust that Chose a Distributions Route According to this position, a distribution from a Relatives Trust who chose the distributions route, to a beneficiary who is a first time resident of Israel, a veteran returning resident or a returning resident, after the end of the benefited period of that beneficiary, will be taxed at a rate of 30% at the date of the distribution, even if the earnings or income it was distributed from accrued during the benefited period.