Multinational organizations sometimes amend or modify the status of companies in their portfolio. Such change may also apply to the legal classification of the entity, for example – change from a corporation into a limited liability company; or in the situs of a company. These changes are sometimes tax driven, while in most cases the objective of the change is to simplify the holding structure, to concentrate a group of entities into one jurisdiction, or to meet certain regulatory requirements.
But, if such changes relate solely to non-Israeli companies, how can they result in Israeli tax implications?
Well, the answer to this question is quite complex. Primarily, because the question is how does this change (either the classification of the entity, or its situs) treated for Israeli tax purposes. Moreover, the relation of both Israeli tax law and corporate law to these situations is quite limited, such that for many years there was no clear legislative answer, neither was an answer in case law, or in literature. Hence, there was an inherent risk that the Israeli Tax Authority would consider the aforementioned changes as liquidation events. If indeed, the company would be treated, for Israeli tax purposes, as if it was liquidated as a result of the said change, then Israeli tax implications may be triggered, in one of the following situations:
First, if the majority of the said company’s value derives from assets located in Israel, this deemed liquidation may give rise to an Israeli capital gains tax event to the so called “liquidated” company. Note, if certain conditions are met, this event may be exempt from Israeli tax under domestic law.
Second, in the event that said company is held by an Israeli company then the Israeli shareholders would be treated as if they should recognize capital gains from the deemed liquidation, in case of direct shareholding; or as if it should recognize CFC income (i.e., deemed dividend income from the underlying deemed liquidation) in case of indirect shareholding.
This ambiguity was clarified, to some extent, a couple of years ago, through a public ruling that related to a subsidiary of an Israeli company that was re-domiciled as part of preparation to an IPO process. The ruling was based on the corporate law of the original jurisdiction of incorporation of the subsidiary, which stated, in abstract, that a company is allowed to change its situs to any other jurisdiction (subject to eligibility under the other jurisdiction’s corporate law), without being considered as liquidated. The ruling also related to the tax law in that jurisdiction, as well as to the tax law in another jurisdiction, in which the re-domiciled company held assets. In both jurisdictions the re-domiciliation was not considered as triggering a tax event.
Notwithstanding the aforementioned, a recent case law (published in August 2018) has added to the ambiguity. In that case, a Luxembourg company of the type that is generally known as a 1929 Holding Regime (the “1929 Company”), held shares in an Israeli company and changed its status of formation into a SOFARTY company prior to realization of these shares. The latter type of company is eligible to benefits of the treaty between Luxembourg and Israel, while the former is not eligible for these benefits. Naturally, the company claimed the benefits and the tax authorities claimed that the sale should have been taxable in Israel, as the transformation of the company was made prior to the sale of the shares, in order to enjoy treaty benefits. It should be noted that the tax authorities ignored the fact that; had the 1929 Company not changed its status, it would have been changed automatically several years after the date of the sale, under certain domestic rules, such that the change of the status of the company was not necessarily made for tax purposes. Moreover, from the wording of the verdict it seems clear that the change of status from a 1929 Company into a SOFARTY could potentially meet the terms determined at the abovementioned ruling. Under this notion, the change of status could potentially not trigger, in and for itself, an Israeli tax event, due to a deemed liquidation of the Luxembourg resident holding company.
The District Court of Tel-Aviv, which did not relate to the Israeli tax implications of a change of status of a company, held that the change of the status of this company was made for the sole purposes of utilizing treaty benefits and therefore held that it was not entitled to treaty benefits.
In summary, it seems that in certain circumstances a change of situs or a change of classification of a company may not give rise to an Israeli tax event. Determination of the Israeli tax implication is heavily based on the applicable corporate law and tax law at the jurisdiction of incorporation of this company. It should be noted though that if this change is tax driven, Israeli courts may be inclined to decide that Israeli tax should apply.
Given the uncertainty in this area, multinational clients who consider such changes that involve Israeli companies – either as shareholder companies or as direct or indirect subsidiaries, should consider such move carefully, taking into account all Israeli and non-Israeli corporate and tax law implications.