Development Expenses Not Included in Property’s Purchase Value

In its hearing on two appeals of rulings issued by appeals committees, the Israeli Supreme Court ruled the Sharvit Rule is valid and in effect. This rule states that as long as the performance of development works did not occur at the time of the sale, the development expenses are not part of the purchase value and purchase tax is not charged in respect thereof.

The Israel Tax Authority

In the aforesaid appeals, the Israel Tax Authority (ITA) ordered the respondents to pay purchase tax not only in respect of the value of the land they purchased, but also in respect of the component of the development expenses they undertook to pay in the purchase agreement signed between the parties.

The ITA believed that, in light of the ruling handed down subsequent to the Sharvit Rule, development expenses should be included in the purchase value on which purchase tax is charged, because they improve the real estate.

The Appeal

However, the Supreme Court rejected the ITA’s position. It ruled for making a distinction between the right to purchase real estate and the right to develop it. The Supreme Court ruled that a contractual undertaking in an agreement between parties to bear the payment of development expenses is not enough and does not stand on its own for including the development expenses in the purchase value of the real estate.

The Supreme Court further defined an exception to this rule, under circumstances when, as a result of the buyer’s contractual undertaking to bear the development expenses, the real estate can be expected to be improved according to the plan applying to the real estate at the time of sale (as in the ruling in the Midtown case).

Thus, the Supreme Court essentially ratified the Sharvit Rule, as follows:

• If development works were not actually performed at the time of purchase, the development expenses will not be considered part of the purchase value and no purchase tax will be paid in respect thereof.

• If development works were performed prior to the purchase date, these works become an integral part of the real estate, and therefore the development expenses are added to the purchase value and the purchase tax derives from this value.

• If the land was partially developed on the purchase date, the development expenses are partially included in the purchase value and in the purchase tax.

This Supreme Court ruling is important and relevant mainly for real estate development companies and land developers. Their purchase tax liabilities will ultimately be lower and they will have more certainty about the costs imposed on them when developing real estate.

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