EXPECTED TAX DECREES IN THE REALM OF REAL ESTATE
Detailed memoranda of law were recently published that include an array of dramatic tax-related decrees. Even the real estate sector was not left immune this time, with the expectation that both the Ministry of Finance and the Israel Tax Authority will act to advance legislative procedures in the Knesset in the land taxation realm soon after the recent Tishrei festivals.
Proposed legislation in the realm of real estate includes the “freezing” (namely, stopping the indexation) of the tax ceilings and brackets that apply with respect to the purchase and sale of residential apartments for a long-term period of three years, including: the purchase tax brackets for the acquisition of residential apartments, the capital gains tax exemption ceiling for the sale of a single residential apartment, the capital gains tax exemption ceiling for the sale of two low-value residential apartments and the tax ceiling benefit for the sale of a residential apartment with attached building rights.
It is clear to all that with the current raging inflationary reality, the impact of the freeze will result in the imposition of a severe and onerous tax burden on both purchasers and sellers of residential apartments. Thus, for example, freezing the capital gains tax exemption ceiling for the sale of a single residential apartment (which today amounts to NIS 5,008,000) without indexation will lead to realistic and progressive erosion of the tax benefit currently bestowed on sellers of apartments.
The tax benefit conferred on tenants is also expected to shrink in similar fashion, so that in terms of the proposed bill, the tax exemption ceiling for the rental of residential apartments, which increased in 2024 from NIS 5,471 to NIS 5,654, will be frozen and not be index-linked. It is anticipated that approval of the proposed bill in this context will result in an increase in rental prices in Israel, due to the rollover of tax costs from landlords to tenants, and will thus also contribute to the prosperity of inflation.
DESPITE THE PUBLIC OUTRAGE – A MEMORANDUM OF LAW ON THE TAXATION OF LOCKED-IN PROFITS WAS PUBLISHED
As previously published by us, the draft taxation chapter and the struggle against undeclared capital as published by the Ministry of Finance a few weeks ago included numerous painful and exaggerated tax decrees, including the taxation of “locked-in profits”.
As may be recalled, the Ministry of Finance’s recommendations in this regard comprised three main pillars: (1) the taxation of “occupational companies” –shareholders in Israeli companies whose rate of profitability surpasses 25% (generally these concern companies that supply services by means of one person, such as doctors, lawyers and accountants) will be charged marginal tax, for their share in profits that surpass 25%; (2) the taxation of holding companies – holding companies will be charged “notional interest” in the scope of 2% annually for profits accrued by them and not distributed to their shareholders, over and above a certain amount described as the “safety cushion”; and (3) a forced dividend – amendment of the provisions of section 77 of the Income Tax Ordinance [New Version], 5721-1961 (“the ITO”), that caters for the distribution of a forced dividend at the order of the Director of the Israel Tax Authority (“the ITA”), thereby enabling the ITA to conduct individual proceedings against those companies whose surplus profits are high.
Despite the huge public outrage spurred on by these proposals, they were fully adopted within the ambit of the recently published Memorandum of Law for Amendment of the Income Tax Ordinance, 5785-2024. On the other hand, attempts by the Prime Minister’s Office to foster an “operation for releasing locked-in profits”, in which a reduced tax rate would be imposed on the distribution of dividends for an allotted period, have yet to take shape.
“THE MAIN THING IS THE INTENTION” – CHANGE IN DESIGNATION OF LAND
A ruling rendered by the Jerusalem District Court was recently published in the case of Mr. Eliyahu Yadid and the Estate of the Late Yaakov Yadid of Blessed Memory, which addressed the issue pertaining to a change in the designation of land. The appellants were partners in the partnership “Eliyahu and Yaakov Yadid – Contractors” which engaged in the construction of apartments for sale and in the execution of construction works. In 1987 the appellants purchased a plot of land in Jerusalem and about 10 years later a building permit was issued for the construction of three residential buildings on the plot of land and on an adjacent plot of land.
Until 2013, the appellants reported about the project in the partnership balance sheets as business inventory beneath the section “Current Assets”. From July 2013, the appellants began to manage the project as an apartment hotel (aparthotel) and changed the manner in which the property was reflected in the partnership balance sheets, so that it would be classified as a fixed asset. The assessing officer ruled that reclassification of the property in the partnership financial statements should be seen as a change in designation from inventory to a fixed asset, and subsequently acted to exercise the provisions of section 85 of the ITO which resulted in the partnership being charged with income for the notional sale of the property for consideration equal to its market value. This ruling led to an increase of more than NIS 56 million in the taxable income of the partnership in 2013!!!
The appellants argued before the court that reclassification of the property in the financial statements should not be regarded as “a change in designation” that establishes a taxable event. As contested by them, when they purchased the land back in 1987 they registered it as a current asset, but from 1997 they designated it as a fixed asset. Accordingly, a report was furnished to the land property tax division within the ITO about the property having become a fixed asset. Moreover, the partnership’s financial statements throughout the years included a comment noting that construction of the project was for rental purposes, with the approval of the Investment Centre. Thus, as asserted by the appellants, in practice they treated the land as a fixed asset as they had habitually done since 1997. The appellants added and asserted that depiction of the project in the partnership balance sheet until 2013 beneath the section “Current Assets” and not beneath the section “Fixed Assets” as required, emanated from an ongoing error on the part of those involved, including the partnership’s accountant.
The District Court accepted the appeal and held that the appellants did well to provide external evidence from which it emerges that in practice they had treated the land as a fixed asset already since 1997. Such evidence teaches that the mistaken recordal of the land in the partnership financial statements as a current asset was done contrary to the appellants’ intention and activities which they sought to carry out in the property. It was thus held that even though the rule is that the manner of recordal of the property in the financial statements purportedly constitutes evidence and even serves as some type of “admission on the part of a litigant” regarding its attributes, this is not a single feature, particularly where in the case at hand all the features demonstrate that this concerns property that constituted a fixed asset of the partnership for many years.
In our view, the said judgment has considerable significance, beyond its specific implementation on the issue of change of designation. The judgment well exemplifies Israeli court rulings and of the need to trace the economic and legal nature of the transaction. These rulings might even serve taxpayers in diverse cases, where the existence of formal features may be interpreted to their detriment, even though their economic nature indicates otherwise.
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