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Tax Plan and Acquisition of a Public Shell

The District Court recently ruled that when a buyer acquires a controlling stake in a company with significant carry-forward losses, without proving or substantiating the existence of any fundamental commercial reason for the transaction, this essentially constitutes an attempt to take advantage of the company’s losses. Therefore, the tax authorities will not allow the buyer to offset the shell’s losses.

The Transaction

Regency Jerusalem Hotel Ltd. was a public shell with accumulated losses totaling ILS 233 million. Hagag Group Real Estate Development Ltd. purchased the company in August 2011 for ILS 18.57 million. The group began launching new activities in the company as of 2012, including organizing real estate purchasing groups. The group claimed it intended to add hotel operations as well, but this did not actually occur. In January 2014, the company became a private company, delisting from trading on the stock exchange at the end of 2014.

The Israel Tax Authority’s Claim

The tax assessor claimed the share purchase transaction constituted an artificial transaction, since its dominant, fundamental fiscal purpose was to save on taxes. According to the tax assessor, Hagag Group intended to transfer its profitable operations to the public shell it had acquired in order to take advantage of the accumulated losses in it. The tax assessor stated that Hagag Group had not proved there were fundamental commercial reasons for the transaction that are on par with or outweigh the fiscal reason.

Hagag Group appealed the tax assessor’s determination and the matter was referred to the court for adjudication. The court ruled, in conformity with previous Supreme Court rulings that the burden of objectively proving the transaction is artificial is on the tax assessor. If the tax assessor succeeds in doing so, then the burden of subjectively proving there is a fundamental commercial reason for the transaction is on the company.

The Appeal

During the appeal, the tax assessor gave several explanations for his determination this was an artificial transaction:

  1. The company did not provide explanations for the acquisition of this specific public shell, even though there were several public shells for sale on the stock exchange at that time.
  2. There were no connections between the company’s previous operations and the operations Hagag Group launched in it (since the company initiated no hotel operations).
  3. According to the company’s financial statements, the company did not recognize a deferred tax asset in respect of the accumulated losses, as is the accepted practice when a company expects to offest losses in the foreseeable future. Instead, the provision for current tax expenses included all of its taxable income without offsetting the accumulated losses. This attests to the fact that both the company and its accountant did not see fit to offset the accumulated losses and did not recognize the expected benefit from their offset in the company’s financial statements.

Conversely, Hagag Group claimed it acquired the public shell for commercial reasons, inter alia, to raise capital from the stock exchange, as indeed happened, and to create flexibility in Hagag Group’s fundraising efforts, as well as to enable the group to launch new hotel operations in a ready-made public shell with hotel activities.

The Court Ruling

The court ruled to examine the matter in a two-stage test. The first stage the court will examine whether the transaction constitutes a legitimate tax planning, i.e., utilizing a tax benefit granted by law, or illegitimate tax planning, i.e., exploiting a loophole in the law. If the court concludes this is a tax benefit deriving from exploitation of a loophole in the law, then the court proceeds to the second stage and examines the artificiality of the transaction. The court found the transaction constituted tax planning deriving from a loophole in the law (and not from a tax benefit deliberately granted by law), and determined the tax assessor had objectively proved a fundamental fiscal reason for the transaction. Therefore, the court deemed the transaction an artificial one. That being the case, the burden passed to the company to prove that, subjectively, there was a fundamental commercial reason for the transaction, which was not fiscal.
After the court examined the commercial reasons for acquiring the company, it reached the conclusion that the fiscal reason for the transaction outweighed the commercial reasons, taking into account the following:

  1. Hagag Group had many other alternatives for raising capital other than through the public shell it acquired.
  2. Hagag Group provided no convincing explanation for the acquisition of this specific public shell, at a time when there were other public shells offered for sale on the stock exchange.
  3. The public shell was delisted from trading shortly after its acquisition, which proves holding a public shell was unimportant to Hagag Group.
  4. Hagag Group launched no hotel operations in the approximate decade since acquiring the public shell.

As a result, the court ruled the acquisition of the public shell constitutes illegitimate tax planning and that the losses cannot be offset.

Public Shells and Tax Planning

In light of the above, it is imperative to plan transactions and business restructuring in advance and in a logical and optimal manner. To the extent possible, it is important to understand the nature of the public shell even before executing the acquisition transaction and to substantiate a fundamental commercial reason for executing the acquisition transaction. Such planning can ensure a more successful transaction and help avoid additional and superfluous post-acquisition tax events.


Barnea Jaffa Lande’s Tax Department is at your service to provide assistance with purchase and sale transactions.


Hanna Daher is a partner and in our firm’s Tax Department.


Tags: Artificial Transctions | Tax Plan