Haifa District Court: Repurchasing of Shares Is Not a Tax Event for Remaining Shareholders

In a bold step, the Haifa District Court rejected the Israel Tax Authority’s position on a company’s repurchasing of shares, and in effect split with a ruling of the Tel Aviv District Court, who considered a similar issue several years ago.

The case in question concerns the settlement of a dispute between the shareholders of Beit Hossen Ltd. As part of the settlement, Beit Hossen repurchased all the company shares of Tzipora Neustadt, one of its shareholders.

The Haifa court’s ruling rested on the central question of whether a private company’s (non-pro-rata) repurchase of shares from one of its shareholders is in effect a dividend distribution to the remaining shareholders. The Income Tax Authority took the affirmative position, as published in its Income Tax Circular 2/2018. The circular’s points were based on the Tel Aviv District Court’s rulings in Baronowski and Bar Nir in 2014.

Judge Weinstein rejected the Israel Tax Authority’s position, as well as the provisions of the Income Tax Circular 2/2018. She also effectively split from the Tel Aviv District Court’s opinions on this issue.

Judge Weinstein held, inter alia, that:

• Under the realization principle, a taxpayer should not be required to pay tax unless he possesses a profit that was realized by him, such that it was manifested by tangible economic gain. Therefore, an increase in the share of holdings without the asset being realized or without some profit does not create a tax event.

• Under the enrichment principle, the increase in the share of holdings does not demonstrate enrichment or an economic advantage for the remaining shareholders. This is because there was a simultaneous reduction in the company’s reserves, out of which the consideration for the repurchase was paid. Thus, the economic value of the shares decreased.

• At the time of the transaction, there is no real certainty of the existence of actual enrichment, even ostensibly in the future, as it is impossible to evaluate the actual enrichment or to quantify the value of such enrichment if it even exists. Moreover, the remaining shareholders were not “shown the money”. Therefore the change in their holdings did not translate into money or monetary value.

• The repurchasing of shares is a legitimate legal tool permitted by the legislature, and a company wishing to remove a shareholder who is in conflict with the other shareholders has a clear financial interest to use it.

Our assessment is that the Israel Tax Authority will not accept this ruling and will appeal to the Supreme Court.

If you have any queries, please contact Adv. Harel Perlmutter.