Share Transfers Between Siblings Are Tax-Exempt – Even Indirect Gifts from Parents

A recent district court ruling broadened the interpretation of the statutory provisions governing exemptions from land appreciation tax and ruled that transfers of shares of a real estate association as a gift between siblings are exempt from  capital gains tax even if the shares were not direct gifts from the parents but originated from land received as a gift from them. The court also prescribed several important procedural rules to improve the protection of taxpayers’ rights vis-à-vis the Israel Tax Authority (ITA).

Factual Background and the ITA’s Position

Pursuant to the Real Estate Taxation Law, transfers of rights in real estate or in a real estate association as gifts between siblings are exempt from land capital gains tax only if the transferring sibling received the rights as a gift or inheritance from a parent or grandparent.

The material issue under deliberation concerns an exemption from capital gains tax upon a transfer of shares in a real estate association as a gift between siblings. In this case, the source of the shares transferred as a gift was real estate purchased by the parents, who transferred a portion thereof as gifts to their children. Later, the mother and children, who retained ownership rights in the real estate, transferred the rights to a company they established with an exemption from capital gains tax x in conformity with section 104B of the Income Tax Ordinance. Subsequently, there was a series of share transfers as gifts, both from the mother to her children and from one sibling to another.

According to the ITA, the share transfers as gifts between the siblings are subject to capital gains tax since, even if the shares reflected the rights in the real estate upon the establishment of the company, the company accumulated additional assets over the years and distributed dividends. Therefore, the shares represent a larger pool of rights than the original real estate transferred as a gift from the parents.

The ITA previously published a ruling on a similar matter. In that case, parents gifted land rights to one of their daughters, which she transferred as a gift to her brother. Subsequently, the brother transferred some of the rights he received from his sister to another sister. The ITA ruled the transfer between siblings was not exempt from capital gains tax because the brother received the land rights as a gift from his sister and not from a parent or grandparent, as stipulated by law.

Court Ruling

Returning to the case at bar, the court accepted the siblings’ appeal and ruled to interpret the law broadly. Therefore, the shares transferred as a gift represent the original real estate that their parents gifted to them, including the shares transferred pursuant to section 104B of the Income Tax Ordinance. Even if the ownership was not transferred directly, the exemption from land appreciation tax still applies. Accordingly, there is no justification for differentiating between shares received as a gift from the mother and transferred between the siblings – a transfer that the ITA recognizes in any case as exempt from capital gains tax  – and other shares transferred as gifts between siblings.

The court also prescribed several important procedural rules to protect taxpayers’ rights vis-à-vis the ITA:  

• A telephone hearing of an objection does not satisfy the audi alteram partema obligation (a fundamental principle of due process anchoring parties’ right to be heard).

Since the Covid-19 lockdowns, online interactions between taxpayers and their representatives and the ITA have become routine. As a result, there are almost no in-person tax assessment hearings, and hearings of taxpayers’ claims, whether self-assessments or objections to ITA assessments, are now telephone hearings. Telephone hearings are often initiated without any official summons – which allow representatives proper time to prepare – but rather are sudden phone calls, sometimes at unreasonable hours.

The court ruled unequivocally, based on reality and experience, that telephone hearings do not constitute a proper hearing of objections, and that such practice violates taxpayers’ audi alteram partema right, which is a fundamental component of due process.

•  Referring to documents in the online system does not constitute lawful service of process.

The court prescribed another important ruling on a procedural issue concerning the ITA’s use of the online system to release itself from the obligation to execute lawful service of process to taxpayers in compliance with the statutory provisions, whereby lawful service of process is only delivery of documents by personal delivery or by registered mail.

Within this context, the court ruled that the ITA failed to execute lawful service of process and that any method other than personal delivery or registered mail does not fulfill the statutory requirements, including issuing notice that the assessment has been transferred to the representative’s system, transmitting it to the Computer Processing Service computer, and transferring it for printing.

• Allowing appeals due to procedural failures.

The court ruled the ITA conducted the tax assessment process in a flawed manner while violating the appellants’ material rights to voice their pleadings, and that this failure also supports acceptance of the appellants’ appeal. This ruling shows that there are instances when failing to execute lawful service of process or denying a taxpayer his audi alteram partema right is sufficient to result in acceptance of a taxpayer’s appeal against the ITA’s ruling, regardless of the materiality of the issue under appeal.

In conclusion:

This recent court ruling demonstrates that share transfers between siblings may be exempt from capital gains tax even for indirect gifts from parents.

The court also prescribed several important procedural rules emphasizing that the ITA must protect taxpayers’ rights even regarding procedural aspects of determining tax assessments and conducting proceedings, and not merely in relation to the material issue in dispute. The court also ruled that a faulty tax assessment procedure, such as unscheduled telephone hearings or failure to execute lawful service of process, may lead to reversal of the tax ruling, regardless of the substantive issue.

We recommend that taxpayers refer to high-quality professionals to thoroughly examine all interactions with the ITA, including procedural aspects, to ensure the objection process is carried out in a proper and fair manner and, if irregularities arise, consider filing an appeal.

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

Barnea Jaffa Lande’s real estate taxation practice provides comprehensive legal advice in relation to tax planning and all of the diverse tax issues that arise in connection with real estate transactions, including urban renewal transactions, combination transactions, transactions for the sale of residential apartments with building rights, purchasing group and local authority transactions, expropriations, leasehold agreements, dissolution of real estate associations, and more.