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.