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Ruling: Pre-Sale Dividend Distribution to Reduce Tax Liability

A district court ruling handed down this past September addresses the legitimacy of distributing dividends prior to a sale of shares in order to reduce the tax liability deriving from the transaction. The court found that, in particular instances, such tax planning is legitimate.


In most cases, the Israel Tax Authority considers dividends of this type, derived from transaction profits, as a part of the transactions consideration, and as such subject to capital gains tax (a rate of 30% in the case of a substantial shareholder).. This is what happened in this case, too, when shareholders of Naama Naot Ltd., including Mr. Avi Toledano, sold all of their shares to Yaleet Footwear Ltd.


Naama Naot owned Naot Footwear, which owns the Teva Naot shoe factory. (We note the factory is entitled to benefits as a preferred enterprise under the Encouragement of Capital Investments Law.)


The sale agreement specified that all of Naama Naot’s shareholders were to receive a consideration totaling USD 65-70 million, from which a “special dividend” totaling USD 25 million would be deducted and distributed to the shareholders prior to the sale of the shares.


At that time, the balance of Naama Naot’s retained earnings totaled about ILS 115 million. In a document from March 2014, Naama Naot’s accounting firm approved a dividend distribution totaling about ILS 89 million.


Said dividend was distributed to all shareholders, including Mr. Avi Toledano, who held 38.46% of Naama Naot’s shares. The distribution was funded from Naama Naot’s retained earnings from its own sources, as well as from a loan totaling about ILS 100 million, provided to it in order to enable the special dividend distribution. (The buyer, Yaleet Footwear, was a guarantor of the loan.)


Israeli Tax Assessor’s Position

The Israeli tax authorities sought to impose a 30% capital gains tax on the dividend distribution, claiming the special dividend constituted part of the consideration for the sale of the shares, instead of the 20% tax imposed on a dividend distribution from a preferred enterprise. The tax assessor also claimed the dividend distribution should be deemed an artificial transaction, since the motive behind the dividend distribution was to illegitimately reduce the tax liability.


Mr. Toledano countered, inter alia, that the company’s share sale transaction stood on its own and that he had a right to withdraw all of the retained earnings that had accumulated in Naama Naot up until the date of the sale. Thus, he argued, he was entitled to the reduced tax rate applicable to dividends from a preferred enterprise.


Court Ruling

The court ruled in favor of Mr. Toledano’s appeal and its ruling addressed several elements of the transaction:

  1. Naama Naot distributed dividends in conformity with the law

    Naama Naot had sufficient retained earnings to distribute the dividend based on the accounting firm’s calculation. In other words, Naama Naot passed the profit test for a dividend distribution. Accordingly, Mr. Toledano was entitled to the dividend distribution.

  2. The acquiring company’s guarantee for the loan obtained by Naama Naot

    The court ruled that this fact does not suffice to change the classification of the dividend, since the acquiring company did not finance the dividend distribution. Naama Naot is the party that obtained the loan and that distributed the dividend; it is the debtor and it is the party which is expected to repay the loan. The court also stated that it is logical for the acquiring company to be the guarantor of the loan obtained for the purpose of the dividend distribution since, besides the fact that it itself received a substantial share of the dividend (about 38.46%), it is the company that will ultimately hold Naama Naot.

  3. Distributable profits

    As for the tax assessor’s claim that the fact the transaction price was specified at a total sum that included the dividend shows the dividend constituted part of the consideration for the shares, the court replied that this is a transaction between unrelated parties and it is possible to agree on a mechanism setting an inclusive price for a company, inclusive of all of its assets, including the distributable profits, which will subsequently be deducted to maintain the net value of the shares. This method of calculation is also consistent with the provisions of Section 94B of the Income Tax Ordinance, whereby a sale of shares can be determined at a particular value, and only after the fact, and within the framework of the provisions of the section, the distributable profits are extracted from the sale price.

    In other words, a shareholder is entitled to withdraw dividends immediately prior to a sale of shares in order to sell them without the distributable profits. Section 94B of the Income Tax Ordinance not only does not rule out this practice, but also itself creates a tax “fiction,” as if the taxpayer distributed a dividend even if he did not actually do so.

  1. The determining date

    The court noted that, although Section 94B of the Income Tax Ordinance stipulated that it will apply to individuals who purchased shares prior to the prescribed determining date (January 1, 2003), such that, prima facie, Section 94B does not apply under the circumstances of the case at hand (Naama Naot was founded in 2006), it ruled that the underlying purpose of the section addressing the need to create tax indifference in connection with a dividend distribution does exist under the circumstances, since the dividend was actually distributed prior to the sale in a way that eliminates the need to use Section 94B to receive the tax benefit. The judge added that this is a lacuna the legislature should amend so that the section’s provisions can also apply, in appropriate instances, to individuals who purchased their shares after January 1, 2003.

  2. Positive or neutral tax planning

    The court ruled that this constitutes positive, or at least neutral, tax planning consistent with the legislature’s intention to entitle taxpayers to receive dividends from a preferred enterprise at a reduced tax rate.

  3. Selective enforcement

    The court also noted that the tax assessor did not issue assessments to the other shareholders, claiming the consideration’s mode of distribution and the transaction structure constituted an artificial transaction. Rather, the assessor approved their reports and the tax rates on the total consideration they received for the transaction as reported by them, including the reduced tax rate on the portion attributed to dividends.


To summarize, based on the aforesaid court ruling, a dividend distribution shortly prior to a sale of shares, distributed for the purpose of reducing the tax liability, can be considered legitimate tax planning under particular circumstances, even if an individual purchased the shares after the determining date, i.e., January 1, 2003.




Barnea Jaffa Lande’s Tax Department has extensive experience in company acquisition and sale transactions and is at your service to advise and assist you in this regard.

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

Tags: Dividend Distribution | Tax Ruling