March 02 2012
InGolan v Assessing Officer Kfar Sava(1)the Tel-Aviv District Court held that a
dividend paid exclusively on shares that were subsequently sold to the
corporation constituted part of the consideration paid for the shares, and was
therefore to be taxed as part of the capital gain achieved on the sale.
The taxpayer and her
brothers inherited the shares of a corporation in equal parts. The heirs did
not get along and later entered into negotiations in order to allow the
taxpayer to part from the corporation. After lengthy discussions, the parties
·the taxpayer's shares would be converted into Class A shares and
the taxpayer only would receive a dividend of IS3,485,000; and
·after the distribution of the exclusive dividend, the taxpayer's
Class A shares would be sold to the corporation for IS1,681,000.
The articles of
association of the corporation were altered to allow for the conversion of the
shares and the distribution of the exclusive dividend. Once the two-step
transaction had been carried out, proper returns were filed.
The assessing officer contended that the dividend received by the taxpayer
before the sale formed part and parcel of the consideration paid on the shares.
It was therefore to be added to the consideration of IS1,681,000 and taxed in
accordance with the capital gains tax regime. This argument was based on the
true 'economic substance' of the transaction or, in the alternative (in view of
the series of coordinated transactions), on the Income Tax Ordinance's
provisions entitling the assessing officer to disregard artificial transactions
whose primary purpose is to unduly decrease tax.
The taxpayer claimed that the dividend had been lawfully distributed in
accordance with the Companies Law, and therefore the assessing officer could
not characterise it differently. The profits of the corporation had not been
distributed in the past because the other shareholders who controlled the
corporation vetoed such a distribution. The dividend paid out constituted the
profits to which the taxpayer would have been entitled had they been timely
paid out. Moreover, the dividend represented past earnings which were paid to
the taxpayer in order to compensate her for the investment risk inherent in the
shares while the consideration for the shares was paid in return for a waiver
of any future rights in the corporation. Finally, the taxpayer claimed that the
assessing officer's assessment brought about a tax of 68% - comprised of the
company tax levied on the company's income and her personal capital gains tax -
but at the time the maximum capital gains tax stood at 50%.
The court held for the
assessing officer. It found that the dividend could not be re-characterised on
the basis of corporate law. It therefore examined the applicability of the
provisions dealing with an 'artificial transaction' to the case at hand.
The court held that
during their negotiations, the parties had negotiated with respect to one sum
payable for the shares. The dissection of the sum into a dividend and the
consideration for the shares was an afterthought. The parties did not negotiate
the value of the shares cum dividend.
The judge then
must comment with all due respect, that in the circumstances of this appeal,
the use of the terminology 'legitimate' impairs the contention raised and is
harms the notion of 'legitimate tax planning'. This is not a case of choosing a
tax savings course as opposed to a fully taxable course in a transaction which
enjoys true economic reasons… The taxpayer did not choose a tax savings course
but rather the construction of a detour which required the alteration of the
corporation's articles of associations…
parties chose a course lacking any commercial reason and it is therefore a far
cry from 'legitimate tax planning'… To create on the eve of the transaction
calling for an exit of a shareholder, discrimination amongst the shareholders,
so that only one shareholder, the taxpayer, who one moment later sells her
shares to the corporation, will be entitled to the dividend, this action is one
whose illegitimacy colors its entirety as such."
The court further held
that an 'artificial transaction' could not be justified by the taxpayer's
desire to achieve a result similar to one denied by the provisions of the
Income Tax Ordinance. The court referred to Section 94B of the ordinance, which
mitigates the tax on that part of the consideration representing retained
earnings of the seven-year period preceding the sale liable to capital gains
tax. In the case at hand, the seven-year limitation barred full enjoyment of
the relief under consideration. The taxpayer could not overcome this bar by
means of an artificial transaction according her an exclusive dividend.
Golandoes not stand for the proposition that
all sales of shares subsequent to a dividend distribution are 'artificial'.
This result was attained because the dividend distribution was made uniquely to
the taxpayer. Had the other shareholders enjoyed the dividend distribution, had
the shares been originally allotted to all the shareholders as class shares
with an economic motive, or had more time elapsed between the distribution to
the taxpayer and the sale of the shares, the results could have been very
different.Golandid not mentionRamsay, but it is
reminiscent of its holding that a preordained series of transactions designed
to achieve a tax savings will not attain its ultimate aim.