Can you cancel a real estate sale transaction and obtain a tax refund or is this a new transaction subject to additional tax?

The Haifa Real Estate Taxation Appeals Committee deliberated the North Mall appeal and ruled recently that a “partial cancellation” of a real estate sale transaction is, in fact, a new transaction in which the buyer is reselling part of the land it purchased, back to the seller.

The North Mall tax dispute

North Mall Properties Nahariya Ltd. and Commercial Center Company (Azo-REIT) Ltd. (“the Sellers”) sold the North Mall and rights to land intended for residential use in Nahariya, to Clal Insurance Group, for a total of ILS 175 million.

Since another new mall opened in Nahariya that was generating stiff competition for the North Mall, a compensation mechanism was added to the consideration, whereby the Sellers would pay compensatory payments to Clal if its annual profit from the North Mall undershot a particular threshold (“compensatory payments”). The Sellers paid compensatory payments to Clal for several years, until a dispute arose between the parties, which was litigated in court and ultimately resolved in a settlement agreement.

The parties reached the following agreements in the settlement agreement:

• “Partial Cancellation” of the real estate transaction – in relation to half of the real estate;
• Clal will refund ILS 67 million to the Sellers according to the value of half of the real estate; 
• Termination of the compensatory payment mechanism;
• Payment of additional one-time compensation to Clal of ILS 53 million, in respect of previous unfulfilled obligations.
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Israel Tax Authority: The “partial cancellation” of the original sale agreement in this case is a resale

After the parties agreed on the settlement agreement, the Sellers , filed a precautionary tax statement in which they reported that the transaction constituted a partial cancellation of the original sale agreement. The ITA rejected the claim and ruled that, under these circumstances, the “partial cancellation” is essentially a resale transaction – i.e. a new transaction, in which Clal is reselling half of the rights it had purchased in the original agreement, back to the Sellers.

The ITA also ruled that the value of the new transaction is ILS 120 million, which includes the two payments referred to in the settlement agreement, and which reflect all considerations paid in the transaction. The Sellers countered with the arguments that, even if it is determined that at issue is a resale transaction, the one-time compensatory payment of ILS 53 million is not part of the payment for the repurchase of the real estate, and that the value of ILS 120 million reached by the ITA substantially exceeds the market value of the real estate.

The appeals committee ruled: a resale transaction solely involves the consideration for the real estate

The appeals committee analyzed whether or not the transaction being cancelled had already been fully executed. The committee reached the conclusion that, although the Sellers claimed that they continued to be involved in the management of the mall during the course of the agreement, the Sellers’ involvement was solely due to the compensatory payment mechanism, which does not negate the fact that the ownership and management of the mall were transferred in their entirety to Clal, which generated profits from the mall’s operation – and that therefore, the transaction was fully executed.

The appeals committee’s view was that the partial cancellation derived from the Sellers’ realization that the transaction was not profitable, which prompted their decision to cancel the agreement in relation to half of the real estate prospectively. The committee ruled that this does not suffice to cancel the agreement retrospectively and restore the situation to its status quo ante.

The appeals committee ultimately ruled that at issue is not cancellation of a sale transaction, but rather a resale transaction – i.e. a new transaction.

However, the committee accepted the Sellers’ argument concerning the value of the resale transaction, whereby the consideration of ILS 67 million was reached between the parties in good faith according to the settlement agreement, and no special relations exist between them. Furthermore, since there is no disputing that this consideration reflects the market value of the property, it is unwarranted to interfere with this value. As for the one-time compensatory payment of ILS 53 million, the committee concurred that it does not constitute part of the consideration in the resale transaction, but rather compensation being paid in respect of the termination of the compensatory payment mechanism.

Implications of this ruling

A decision to cancel an agreement is not a guarantee that the real estate tax authorities will accept the cancellation and refund the taxes paid in the transaction to the parties.

Another salient point to keep in mind: if the parties cannot prove that the transaction was not fully executed and that the situation can be restored to the status quo ante, not only is there a possibility that the tax paid will not be refunded – but it is also possible that the ITA will deem it a new transaction for all intents and purposes, and therefore obligate the parties to pay tax in respect of the new transaction.

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Adv. Maya Carmi Lubartovski heads the firm’s real estate taxation practice.

Itay Edelstein is an intern in the tax department.

Our firm provides comprehensive legal advice in relation to all real estate tax issues, including tax planning and the various tax issues arising during real estate transactions.