On the seam between the business world and the family world, a fascinating and problematic overlap is revealed. It creates inequality regarding trapped-in capital gains, which has led to a series of fascinating rulings and articles on the subject.
Let’s take for example a couple who divorced after decades of living together, during which they accumulated holdings in corporations worth about NIS 20 million, financial investments of NIS 10 million, and apartments worth NIS 10 million.
When a couple divorces, the transfer of assets between them as part of the balance of resources, as required by Israeli law, is not considered a taxable transaction – not betterment/purchase tax and not corporate taxes. In practice, when balancing resources, a tax deferral occurs.
Tax Analysis
In our example, if the real estate worth NIS 10 million were sold to a third party, the parties would have paid betterment tax of NIS 2 million and would each be left with NIS 4 million net, whereas in the balance of resources, the spouse remaining with the real estate would have to pay the other spouse NIS 5 million (half of the gross) in order to purchase the rights in the property.
The same applies to the holdings of the corporations – the spouse who wishes to continue to hold the business interests worth NIS 20 million will pay the other spouse half of the gross value, i.e. NIS 10 million. If that spouse had sold the business to a third party and was taxed, that spouse would have been left with a net sum ranging from NIS 10-15 million.
If the company has a connection to another country, that country’s taxation must be considered as well. For example, if one of the divorcing spouses is a U.S. citizen, any transfer of the U.S. spouse to a spouse who is not a U.S. citizen following a divorce, is taxed as a capital gain.
Possible Negotiations
When balancing resources per Israeli law, the couple is actually exposed to legal uncertainty on several levels. They do not know when the future tax will be charged. They do not know whether the assets will ever be sold to a third party. They cannot know what the legal situation will be at the time of realization of the property; whether the same family laws will apply or whether there will be a change in the law. Of course, the same issue arises regarding tax laws as there may be a change in the actual imposition of the tax or in the tax rate.
Conclusion
We strive for maximum certainty and stability for our business customers in light of the built-in disparity between the business world practicalities, the clear and strict tax laws and family law. This disparity creates an illogical and unfair result for one or both of the spouses. Unfortunately, it can also result in prolonged disputes or escalation of already existing differences. Therefore, we advise our clients to draw up agreements to create certainty for the family, the business and generations to come. The framework of intergenerational transfer processes provides opportunities to forge creative solutions effecting enlargement of the whole family’s pie.
