Tax Alert No. 39 - 13.9.2021

The ruling in the GFI (hereinafter: “The Appellant”) case was published recently.

The Appellant is an English company, which established a branch in Israel and which is engaged in the provision of a range of financial services, including brokerage and arbitration services to institutional customers (the Appellant has a defined group of customers – banks, insurance companies, investment funds and etc.) in Israel and across the globe, in consideration for a commission.

The Appellant has signed on a facility agreement for the provision of a range of financial services and “products” with each of its institutional customers and the commission is set with each customer in accordance with the service that is provided to it. The list of projects may vary from customer to customer, as may the level of the commissions.

The appeal deals with two of the Appellant’s “products”: futures transactions in foreign currency (mostly shekel – dollar) and also in swap transactions between interest rates, a fixed interest rate against a variable interest rate. An “initiating” customer (for example an Israeli bank or a foreign bank) approaches the branch and requests a range of prices for the execution of a transaction (it is not known at this stage whether this is for a purchase or for a sale). The handling trader distributes the range of prices that is requested to its other customers, and he receives a range of prices from among them. At this stage, notification is received from the initiating customer regarding whether he is interested in buying or in selling. The trader approaches the customers from which he has received an appropriate range of prices again and a negotiating process is started, which continues until there is agreement with a counter customer and a transaction is signed, for which the branch is entitled to commissions from both of the customers, in accordance with the facility agreement.

The initiating customer can be Israeli or foreigner and the counter customer can be Israeli of foreign.

If both of them are Israeli, the commissions from both of them is chargeable with VAT. If both of them are foreigners, the commissions from both of them are chargeable with VAT at a zero rate and if one of them is Israeli, then VAT will apply to the Israeli party, and a dispute has arisen regarding the service that is provided to the foreign resident in this instance. The Appellant claims that a zero rate applies, and the Director of VAT claims that this is one transaction involving brokerage between both of the parties – even though the service is provided to a foreign resident, in parallel, service is also provided to a resident of Israel and therefore it is excluded in accordance with the provision of the law, which determines that a service that is provided to a foreign resident where the subject of the agreement is the actual provision of the service to a resident of Israel in Israel as well.

In this regard, the Appellant claims that there are two separate agreements, for two different services, and each party bears its own commission and the service to the foreign resident is entitled to VAT at a zero rate.

The court has accepted the appeal:

• The language of the qualification in the section determines that VAT at a zero rate on service to a foreign resident will be negated insofar as the subject matter of the agreement between the provider of the service and the foreign resident, is also the actual provision of service to a resident of Israel in Israel.

In the case in hand we are not dealing at all with an agreement that relates to a resident of Israel in any way (and it is not even clear if there will be such at all). There is no concern of artificiality regarding this fact.

• From a practical perspective, there is no disputing that service is provided to both of the parties, a service is provided to a resident of Israel and a service is provided to the foreign resident. The Court compares the Appellant’s activity to that of a real estate agent, who has a community of customers who are interested in purchasing an apartment and a community of customers who are interested in selling apartments. Is the situation one in which the same real estate agent represents both the seller and also the buyer, is this one service for both of them? The Court determined that this is not the case!!

The Judge mentioned the following reasoning on this issue:

• • In the circumstances of the case in hand, since these are permanent customers, without an emphasis on a single transaction, this is an ever-clearer case than a non-recurring brokerage act.

  • There are permanent separate agreements with the customers.

  • The customers are permanent customers who receive a range of services. The commission rate is determined for the generality of the services and not in relation to the specific transaction.

  • The service to each party is not connected to the identity of the counter party but rather it expressed the presentation of a price that is appropriate to the parties’ wishes.

  • The service to each party is not connected at all to the identity of the other party, but rather expresses the presentation of a price for a product that is sufficiently close to the party’s wishes. There is no sort of cooperation here between the parties in order to maximize the economic benefit and for certain there is no ordering of service here by one party in order to cause an improvement or a benefit for the other party.

  • In effect, different services are inherent in the meeting and the brokerage for the different recipients, and not the very same “service” – and this is not because of the absence of similarity in the content of the services but rather because of the gap in the interests and the desires.

And in brief, and as part of the presentation of examples – the Court determines that where the issue is one where a service is given to 2 parties for the parties of achieving results, each of them has their own interests, where the objective is to find a compromise between them such as in a brokerage transaction for land, where the estate agent represents both of the parties, investments brokerage, matchmaking, arbitration and etcetera – this is a service that is given to each of the parties separately, and the VAT is to be handled accordingly.

As an aside, the Court ruling relates to two important ancillary issues:

The substance of the zero-rate relief for a service that is provided to a foreign resident

Some of the substantive issues are the encouragement of the export of services and bringing foreign currency into Israel and assisting Israeli businesses in competing opposite foreign businesses in the international service markets.

And indeed, the VAT director claims that in the circumstances of the case there are no grounds for or need to encourage the appellant to grant the services that are connected to the products in question, that in any event the establishment of a branch and the Israeli team is necessary from a commercial perspective.

Accordingly, the Court responds:

that even if on the factual plain this claim has substance, the language of the law is broad, and it absolutely may apply to cases in which no encouragement or assistance in international competition is required.

There are many examples – for example, a journalist who is a resident of Israel whose services are hired by a foreign publisher of travel guides in foreign languages in order to put together a chapter of a book on restaurants in Israel, with a description thereof and a rating thereof. What is more natural or necessary that engaging an Israeli restaurant critic to do this work, and despite this, prima facie, there is no impediment to imposing VAT at a zero rate on such a case.

An asset that is located in Israel

The Director of VAT claimed that the agreement between the Appellant and the foreign resident is an asset that is located in Israel, and accordingly and in accordance with the qualification in the law – VAT will not apply at a zero rate.

On procedural grounds, and when this claim was not made by the Director in more preliminary stages, the Court was not prepared to discuss this claim. However, it went further and determined that the parties’ rights that are created in the financial transactions are not necessarily “an asset that is located in Israel” and it would appear that this issue, where the discussion involves complex financial products, is not a very simple one.

We can summarize by saying that in the special circumstances of the case in hand, it is not certain that the Tax Authority will appeal to the Supreme Court on the ruling. Even if an appeal were to be submitted, and so long as it has not been accepted – the harsh, restrictive approach that has been adopted by the Tax Authority regarding the provision of the zero-rated VAT benefit on a service that is provided to a foreign resident has been fractured and has become much more open.

An exemption from tax is granted by law to a foreign resident on a capital gain that he has had on the sale of a security of a company that is resident in Israel or on the sale of a rights in a foreign resident body of persons, the main assets of which are rights, directly or indirectly, in assets that are located in Israel (“The security“), if certain conditions are met.

According to the OECD’s model treaty, a capital gain on the sale of a security in one country (which is not substantively a right in land) by a resident of another country, is only chargeable with taxation in the other country. This principal has been adopted in treaties that Israel has signed upon in recent years, however in order to determine uniformity on the matter, all of the tax treaties that Israel is a party to, and in order to encourage foreign investments also by foreign investors who are not residents of a treaty country, a similar determination to the determination in the treaty has been made in the internal law. The explanatory words to the law express the legislator’s intention to correct what is stated in order to encourage foreign residents to invest in Israel and to avoid the discrimination that existed between foreign resident investors from different countries immediately before the amendment.

However, to differentiate from the provisions of the exemption in the model treaty and in many treaties that Israel is a party to, one of the conditions for the granting of the exemption under the internal law in Israel is that the security has not been purchased from a relative. Accordingly, pursuant to the provisions of the law, a foreign resident who has purchased a security issued by an Israeli company from a relative and is now interested in selling the security, will not be exempt from capital gains tax on its sale (in the absence of a treaty).

It is reasonable to assume that in this way the legislator wanted to prevent the “smuggling” of assets out of the Israeli tax net, such as in a case in which a resident of Israel who sells a security to his foreign resident relative at a reduced price or as a gift, and the latter sells the security afterwards to a third party at full price under a tax exemption; or alternatively, a foreign resident who is not exempt from tax, who transfers a security to his foreign resident relative at a reduced price or as a gift.

However, the granting of a security as a gift to a foreign resident relative is chargeable with taxation, pursuant to the exception in the provisions of the law that does indeed grant an exemption at the time of the gift to a relative, but only on condition that the recipient of the gift is not a foreign resident; this, is whether the transferor is a resident of Israel and whether they are a foreign resident. And if the negation of the exemption derives from the basic assumption that even though the issue is not one with a gift, but rather “only” a sale to a relative not at arm’s length, so there are numerous cases in the Ordinance in which it is possible to avoid tax as a result of the determination of a price for a transaction, which is lower than the market price, and the way to cope with them is not the negation of the tax rights in an all-encompassing manner.

It is possible, at the most, to make the exemption conditional upon an objective value index for the purchase price, such as reporting to the tax authorities abroad or the performance of an evaluation. The negation of the exemption leads to unreasonable situations! Thus, for example, pursuant to the provisions of the law, a foreign resident who has purchased a security in an Israeli company from his relative at full price, and who is not interested in selling the security, will not be exempt from capital gains tax on the sale. Similarly, the exemption will prima facie be negated at the time of the sale of the security to a third party, insofar as we are dealing with an individual who has received the security as in inheritance from his father, even of the bequeather and the inheritor are both foreign residents who would be entitled to an exemption from tax, were it not for the qualification that we are discussing. In the case of bequeathing, as is well known, bequeathing does not constitute a sale and therefore in our opinion, it can be concluded that the receipt of an inheritance in a bequest will not constitute a purchase, such that the exemption will not be negated in this case.

It would appear that this is not what the legislator intended, and a provision of this sort certainly does not achieve the substance of what the legislator intended, which was meant to be equality between foreign investors and the encouragement of foreign investments.

Finally, we would mention that about three years ago, the Taxes Authority published a tax decision (which was not by agreement) on the subject of the transfer of shares in an Israeli company as a gift from a foreign resident father to his son who is a resident of Israel (“The Israeli son”) and who has the status of new immigrant, where afterwards the Israeli son will sell the shares. The Taxes Authority negated the exemption at the time of the sale of the shares.

We would like to make it clear that the case in the tax decision is different from the above case, in particular because of the fact (which is mentioned explicitly in the tax decision), that if the foreign father had sold the shares to the Israeli son, they there would have been an exemption from tax on the capital gain, however the father would have been charged with tax in his country of residence.

To summarize: in our opinion there is a lacuna in the law, which should be corrected by the legislator, until when, it would be appropriate for the Taxes Authority to publish a lenient interpretation or one that clarifies the issue.

A “new” term has entered our world in the past two year, which is becoming more common and is starring throughout the economic press.

So what, in effect, is an SPAC?

An SPAC (Special Purpose Acquisition Company), is a corporation, the entire objective of which is to raise money from investors, whilst determining a general definition pursuant to which the corporation’s objective is investment in companies in certain fields or in certain locations. In other words, when raising funds, there is no specific activity for which the funds are raised, but rather cash flows are raised and an issue is executed in reliance on the entrepreneurs’ reputation (“The sponsors”) and the investors’ trust in them, that they will select high quality target companies that will generate considerable value for the investors.

The advantage of this process for the target companies, companies that are interested in raising equity is that not only does it promote their interests, but they also save a significant part of the complex process involved in a “regular issue”.

Generally, a merger or an acquisition of the target company by the SPAC is done in one of two main ways, each of which has different tax implications or solutions and insofar as the shareholders in the target company and/or the target company and/or the shareholders in the SPAC are residents of Israel.

The first alternative:

A merger by way of the exchange of shares in the (Israeli) target company with shares in the SPAC, such that at the end of the process the SPAC will hold the entire share capital of the target company and the SPAC’s capital will be held by the original shareholders of the target company together with the shareholders in the SPAC. Of course, the cash flows from the issue through the SPAC will be directed to the target company as in investment in capital or in some other way, such as capital notes, loans and etcetera.

However, in some cases whether for tax considerations in Israel and/or in the United States, the structure of an American company’s holdings in an Israeli company may lead to tax liabilities in the United States, as a result of various anti-planning provisions, the implications of which need to be examined separately.

The second alternative:

Sometimes, because of commercial and/or legal considerations an alternative is selected within the context of which the target company will serve as the parent company, which is done by means of a reverse triangular merger. The target company will acquire all of the shares in the SPAC by establishing a new, wholly owned, subsidiary company which will merge with and into the SPAC, such that at the end of the process, the target company will hold all of the shares in the SPAC. The shareholders in the SPAC will receive new regular shares, which will be issued to them in the target company, in consideration for their shares in the SPAC.

We would mention that prima facie, if there are no Israeli shareholders in the SPAC, no tax event occurs in Israel.

The balance of the cash that is held in the SPAC will be transferred to the target company by means of a reduction in capital or by way of the self-purchase of shares.

Could a reduction in capital or a self-purchase be deemed to be a dividend?

A tax decision was published in 2020, which determines that a reduction in capital and a self-purchase in a SPAC company, as described in the second alternative, , insofar as there are no retained earnings in the SPAC, the transfer of monies from the subsidiary to the parent company by means of the reduction of capital or a self-purchase, will not be deemed to be a distribution of a dividend but rather a capital gain, which will not cause a tax liability (insofar as the consideration does not exceed the cost of the shares).

There are additional alternatives for the making of a structural change when recruiting funds through an SPAC. It is recommended that all of the alternatives be considered and that advice should be obtained before making a structural change.

As is common knowledge, the Taxes Authority has expressed its opinion regarding cryptographic currencies such as Bitcoin (which we will be relating to as a representative example in this article), pursuant to which it is an “asset”, and accordingly, a sale type transaction, including a conversion between currencies, may generate a capital gain, which is chargeable to taxation in Israel (or a capital loss, which can be offset in the appropriate circumstances).

One of the questions that arises in this regard relates to the place where the capital gain on the sale of the virtual currency is generated. One of the central implications that derive from a decision on this issue relates primarily to someone who is classified as a new immigrant or a returning veteran resident (“A beneficiary individual“).

So, insofar as the issue is with a capital gain deriving from an asset that is located outside of Israel, so this is a capital gain that is exempt from tax in the benefits period that applies for that beneficiary individual (and on the other hand, a capital loss will not be recognized for tax purposes).

So where is the bitcoin?

A bitcoin is not a tangible asset, but rather it constitutes a digital right with an economic value for its holder, where this right is highly marketable, although not on a regulated market but rather on various trading platforms. This right is embodied in agreement of the “community (a decentralized worldwide computer network, which enables a chain of transactions in the currency), pursuant to which a particular quantity of coins, which are the subject of a transaction are attributed to a particular public address. Whoever has the private key to that public address (in effect a sophisticated password), has, in effect, the economic ownership of those coins.

Is it possible to attribute the properties of a security to a bitcoin in this connection?

Even though a bitcoin does constitute an “asset”, as we have stated above, it does not constitute a security.

If we compare a bitcoin to a security (a share or a bond, for example), we will find that there is not really any room for a comparison. Whereas the place where a capital gain on a share or a bond is generated is the country of residence of the company whose shares are being sold or which has issued the bond, whereas when we look at a bitcoin, there is no central factor to which the economic right can be attributed and accordingly it does not have a geographical location.

An additional aspect in connection with a comparison to a security, is the exemption that a regular returning resident (other than a veteran resident) is entitled to on the sale of “beneficiary securities” (a securities portfolio), in a manner that enables the exchanging of securities within the portfolio without impairing the exemption that is provided in relation to a dividend, interest and a capital gain from those securities.

Prima facie, the alleviating provision that is mentioned above will not apply and accordingly the conversion of a bitcoin that has been purchased by a foreign resident when they were a foreign resident into a different sort of currency after their return, may not be exempt from tax on the sale of the exchange currency in the future since this is already an asset that has been purchased after their return to Israel.

We would mention that despite the aforesaid, there are still other ways to protect and to maintain the exemption for the returning resident, who holds digital currencies, even if they are exchanged.

An interesting question in this connection is what the law is regarding a situation in which it is determined by a regulatory authority (the Securities Authority in Israel or abroad) that a particular currency, which has been issued by a company constitutes a security type currency (Security Token). In this case will the abovementioned provisions apply as they apply to “regular” type securities? This is something that needs to be pondered.

Additional possibilities for determining the location of the asset

A claim that could be brought up in this connection is that the place where the key for the item is located when the transaction is executed constitutes an indication for the asset’s location.

This claim is not without problems, since the key for an item is nothing other in practical terms than a password, which enables access to that public address, and as such, neither does it have a geographical location. The fact that an individual can use the same key when he is staying in a particular location does not indicate the physical location of the private key, even if it is stored on physical hardware (which is called a “cold wallet”), which is located in the place where the seller is located.

In addition, transactions in digital currencies are generally executed through a trading platform (exchange), and in the overwhelming number of cases, they are not located in Israel. In such a situation, a customer of that platform merely inputs orders (just like an individual who inputs orders for the sale and purchase of shares), however the platform is what makes use of its private keys in order to execute those orders.

An additional indication for the question of the location of the digital currency, may be the location in which the legal rights that are inherent in that economic right are anchored, for example – the ability to sue for ownership of the currency. This indication may be decisive in relation to the location of a patent, for example. However, since there is no person or legal body that can grant validity to the ownership of a bitcoin, but rather it is with the agreement of a decentralized computer network, as mentioned above, which not subject to any regulatory body, so this parameter too does not help us to examine the question.

If we refer to the spheres of the economic location of the intellectual property (IP), inter alia, in light of the BEPS (Base Erosion & Profit Shifting) provisions, so the location of the development of that IP (and in effect the location where the significant decision regarding development are made) may determine the location of the asset for tax purposes, even if the property ownership in it is different. And again, even in this case it is not possible to attribute the location of the asset to Israel, since apparently, the code that bitcoin launched was not developed in Israel (we are talking about a person/ body whose pseudonym is Satoshi Nakamoto), and even the mining activity, which gives birth to a fixed number of bitcoin tokens every fixed number of minutes is also performed across the globe, as mentioned above.

In light of all of the aforesaid, it would seem that a bitcoin and other similar assets should be viewed as assets that are located outside of Israel (even in the absence of the ability to identify a specific country in which they are located), and accordingly, a capital gain on their sale by a beneficiary individual will be seen as a tax-exempt capital gain during the benefits period.

This interpretation fits, of course, with the main objective of the New Immigrants Law – the encouragement of immigration and the return to Israel by imposing taxation in Israel, which is similar to the tax applies in relation to foreign residents.