In November 2007, a significant tax Decision (Income Tax Appeal 1226/02) was issued by the Tel Aviv District Court. According to that Decision, dividend stripping, i.e., the transfer of shares of a company immediately prior to dividends distribution, should be considered as two separate transactions, for tax purposes: (a) transfer of shares; and (b) the right to receive dividend income on a specific day.

The Israeli tax implications on non-Israeli residents may be significant, mainly with respect to the determination of the jurisdiction of source for capital gains purposes.

(a) Transfer of Shares – In case a non-Israeli resident sells shares in an Israeli resident company (or shares of non-Israeli resident company where most of its assets are located in Israel) the Israeli tax implications are clear – since the sold asset is located in Israel for Israeli tax purposes, according to the ITO (Section 89(b)), Israel may impose its taxing rights on such gains sourced in its territory.

 (b) Transfer of right to receive dividend income – according to Israeli tax law, in determining the source of dividend income, the jurisdiction of the distributing company will also be regarded as the source jurisdiction of the dividends. Accordingly, in case the relevant company is a non-Israeli resident company that mainly holds assets or real-estate in Israel, the sale of its shares by a non-Israeli resident will be regarded as a sale of asset located in Israel and Israel may exercise its taxing right, but as for the right to receive dividends, the source jurisdiction would be in such company’s state of residence and Israel may not tax such right for dividends.

It should be noted that gains related to such a right to receive dividend may be classified as gains from the alienation of “other” property, according to most of Israel’s tax treaties and the taxing right would exclusively be of the “state of residence of the alienator”, i.e., outside Israel.