May 18 2012
On March 29 2012 the Tel Aviv District Court ruled on the taxation of insurance
enterprise caught fire and a building and machinery were destroyed as a result.
The assessing officer sought to tax the compensation received for the building
and machinery as a capital gain, and that received to cover leasing expenses as
ordinary income. The taxpayer contested the assessment, arguing that since no
asset was sold a capital gain could not arise. Furthermore, the amounts
received to cover leasing expenses were capital sums and hence not liable for
The question further
arose as to whether the taxpayer was entitled to the benefits accorded to
manufacturers during the tax year of the fire, in which all production was
subcontracted to subcontractors due to a lack of production facilities.
The taxpayer had
contended, in respect of the capital gains assessment, that a capital asset was
not disposed of as the building was reconstructed and remained in its
possession. In short, the destruction of the building did not constitute its
fiscal sale. However, the court rejected this argument. The definition of a
'sale' requires merely that the asset in "any manner whatsoever no longer
be in the possession of the taxpayer". This definition is broad enough to
cover the destruction of the facilities, since subsequent to this destruction,
the taxpayer no longer possessed the facilities.
The court was further
required to clarify whether the building was an 'asset' for capital gains
purposes. The taxpayer argued that had the building been sold, it would have
been liable for tax under the Land Tax (Appreciation and Purchase) Law 1963 and
was therefore excluded from the definition of an 'asset' under the Income Tax
Ordinance. However, the court held that the compensation did not give rise to a
liability for appreciation tax, as under the law no sale had occurred. Hence,
the building was not withdrawn from the broad definition of an 'asset' for
capital gains purposes and its 'sale' gave rise to a taxable capital gain.
The court went on to
hold that the fire was tantamount to the realisation of the machinery and
building, and where such a realisation gives rise to a gain, the latter is
As a rule, the profit
derived from compensation is characterised in accordance with the subject
matter thereof. Where capital assets - such as a building and machinery - are
compensated for, the compensation takes the nature of the consideration
received in a capital transaction.
The taxpayer was
compensated for leasing and other payments it incurred. The compensation
received exceeded these payments. The court held the excess to be ordinary
income because the payment was made to cover ordinary expenses incurred in the
production of income. The excess could not transform into a capital receipt.
The taxpayer's contention that the excess compensation should not be taxable,
since the Income Tax Ordinance explicitly disallows the deduction of expenses
that were recovered from insurance, was rejected by the court.
Finally, the court
decided that the taxpayer could not enjoy the benefits accorded to
manufacturers under the Law for the Encouragement of Capital Investments 1959.
As a result of the fire, the taxpayer lacked manufacturing facilities, and
subcontracting was no substitute for these. The taxpayer therefore had no
manufacturing activities, which were an essential condition to the granting of
the tax incentives under the law.