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New Israeli Court Ruling on Artificial Transactions

A recent court ruling in the Shalam Packaging Products Group case addressed claims made by the Netanya tax assessor. The assessor argued the group executed a restructuring solely to reduce its tax liabilities by offsetting business losses against a capital gain from insurance payouts. These payouts resulted from fire damage at one of the group’s plants.

Background to the Restructuring

Shalam Packaging Products (1998) Ltd., the group’s parent company, manufactures and markets plastic packaging products at its industrial plant in Caesarea. The parent company owns several companies at various holding amounts. One such subsidiary is Shalam Packaging Solutions Ltd., which owned an industrial plant in Yakum that manufactured plastic containers and stoppers.


The parent company acquired the subsidiary’s shares in three stages. This process began in 2008 and concluded with the acquisition of 100% of the shares in 2013. The parties signed the first agreement to acquire 50% of the shares in 2008, the second agreement for 15% in 2012, and the third agreement for the remaining 35% in 2013.

Between 2009 and 2013, the subsidiary incurred cumulative business losses totaling about ILS 54 million.


In January 2014, the parent company filed a notice of restructuring with the tax assessor. Under this notice, the company transferred assets to the subsidiary in accordance with Section 104A of the Income Tax Ordinance. In return, the subsidiary allotted shares to the parent company.

Tax Assessor Disallows Offsetting of a Business Loss from a Capital Gain


Subsequent to the acquisition and the restructuring, the subsidiary transferred the operations of its plant in Yakum to the parent company’s plant in Caesarea. This same plant, after the restructuring, served the parent company, the subsidiary, and the parent company’s related companies.


In June 2014, about six months after the restructuring, a fire broke out at the Caesarea plant. Menora Mivtachim insured the group’s assets in the factory and paid out a total of ILS 155 million to the insured companies. The group’s companies reported to the tax assessor the capital gains from the insurance payouts.

The subsidiary’s annual report for 2014 reported an offset of a significant portion of the business loss against taxable income totaling about ILS 45 million from the capital gain from insurance payouts in respect of the fire damages.


However, the tax assessor claimed the parent company executed the restructuring, including the transfer of its operations to the subsidiary, in order to offset the company’s business losses from the taxable income from the joint operations. According to the tax assessor, this constituted an artificial transaction intended to enable an improper tax reduction.



Therefore, the tax assessor decided to disallow the offset of the losses and to issue a tax assessment charge to the subsidiary accordingly.


The tax assessor also addressed the subsidiary’s income from debt forgiveness of capital notes from its previous owner, an association belonging to Kibbutz Yakum.


Capital Notes

Before Shalam completed its acquisition of the subsidiary, the association held capital notes in respect of investments it previously injected into the subsidiary totaling about ILS 49 million. The tax assessor claimed these were not perpetual capital notes but rather regular current liabilities (perpetual capital notes are capital notes with no defined repayment date, which constitute part of the subsidiary’s capital assets and not part of its liabilities. Section 3(b) of the Income Tax Ordinance addresses debt forgiveness and not capital forgiveness).


The tax assessor determined the association had effectively waived the subsidiary’s payment of these liabilities within the scope of the last acquisition agreement.

The assessor also determined that income from debt forgiveness must be credited to the subsidiary in accordance with Section 3(b) of the Ordinance. This income must be offset against the business loss, rather than the capital gain from the insurance payouts.


The Court Ruling

The court rejected the tax assessor’s claims and ruled as follows:


Attributing insurance payouts to the subsidiary

The court ruled the subsidiary may offset ILS 37 million from the business loss. The gains from insurance payouts are clearly attributed to the subsidiary, not the parent company. This ruling is based on an objective assessment by an external appraiser appointed by the insurance company.


Offsetting business losses according to a shareholder’s holding ratio

The Supreme Court ruled in the Ben Ari case that a shareholder may offset business losses based on its relative holding ratio in the investee company at the time of incurring the losses. This ruling applies even in the absence of a commercial reason for injecting new activities into a company with accumulated losses.

In the case at bar, the court held that it is indisputable that the subsidiary incurred its losses beginning in 2009, when the parent company already held 50% of the subsidiary’s shares.

Therefore, the court ruled the parent company may offset, at the very least, a pro rata of the business loss against its income according to its holding ratio of the subsidiary at the time it incurred the losses.



Rejection of the claim of an artificial transaction

In general, tax law typically defines an “artificial transaction” as lacking fundamental commercial purpose, driven solely by tax planning. However, the court emphasizes evaluating the legitimacy of tax planning and balancing various interests. In the Shalam case, the court determined that a substantial commercial purpose was evident, leading to the rejection of the artificiality claim.


During the court’s analysis, it referenced the Yoav Rubinstein case, which dealt with artificial transactions. However, in this case, genuine business conduct spanning years was observed. The restructuring involved two companies in related businesses, manufacturing plastic packaging with different technologies. The rationale was to exploit beneficial synergies between the companies.


If we compare the case at bar to the Rubinstein ruling, in which a contractor acquired an ornamental fish company, and to the Ben Ari ruling, in which an insurance company acquired an automobile repair business, the disparity between the cases is obvious. The case law underscores the contrast between artificial transactions for tax purposes and genuine synergistic economic operations facing challenges. In the case at bar, these challenges necessitate prompt action to halt losses and regain profitability.



Rejection of the claim about generating income from capital note forgiveness

The court ruled that the status of the original capital notes were reclassified to perpetual capital notes under the first acquisition agreement. This is because the parent company’s commercial logic at that time was to ensure the association would not call for the repayment of the capital notes it held. This thus ensured the parent company would have the same standing as that of the association.


Accordingly, the subsidiary has classified the capital notes (totaling ILS 49,758,567) as perpetual capital notes in all of its financial statements since 2008. In light of this, the judge ruled the capital notes are perpetual notes and that Section 3(b) of the Income Tax Ordinance does not apply under the circumstances.

Therefore, the court rejected the tax assessor’s claim and authorized the group to offset the business loss from the capital gain from insurance payouts to the group.



Barnea Jaffa Lande’s Tax Department has extensive experience in acquisition and sale transactions and in various types of corporate restructuring. It is at your service to advise and assist.

Adv. Hanna Daher is a partner and Adv. Alon Davidovich is an associate in the firm’s Tax Department.

Tags: Artificial Transactions | Tax