Is purchasing a business such as a hotel or a shopping center is an action which constitutes a tax event in accordance with the Land Taxation Law? In order to answer the aforementioned question, it should be examined whether the transaction constitutes an “action” in the “property association”. The meaning of classifying the transaction as an action in the property association is whether or not land taxation should be imposed, therefore the great economic significance which lies in a classification as stated. In this article we will present decisions made by the tax authorities and rulings made by the courts which have examined various transactions recently, and we will try to note the relevant tests for classifying and deciding on the matter.
The Land Taxation Law (Betterment and Purchasing), 5723-1963 (hereinafter: “the Law”) imposes a tax debit on selling and purchasing rights in a property, including land, houses, buildings and more. In addition, the Law imposes a tax debit on an action in a property association. In this article we will focus the discussion on this type of tax event – an action in a property association.
What is an “action” and what is a “property association”
The Law defines an “action” in a property association as granting rights in a union, including the selling and purchasing of stocks, whether with or without consideration, but excluding allotment of shares. The meaning of excluding such allotment is non-imposition of betterment tax or purchase tax on the transaction.
The rationale underlying the exclusion of the allocation is that the value of the original shareholders’ holdings (despite the dilution) has not changed, since the assumption is that a person will not waive his rights without consideration. The Rothchild Shopping Center case (which will be discussed in detail hereinafter) examined an allocation of shares made in a company which held the shopping center to another company, which granted the latter 99.9% of all rights in the company. The Appeals Committee ruled that such dilution constitutes an extreme allocation which and is not included in the allocation permitted by the Law as it is against the rule’s rationale. Therefore, and despite the fact that this was a share allocation, the exclusion in the Law shall not apply.
A “property association” is defined in the Law as a union (including a limited company and a registered partnership) which all of its assets, directly and indirectly, are rights in property. For this matter, the following shall not be regarded as a union’s assets – cash, shares, debentures, securities and movables which do not serve the union in creating its income, or which are used for creating income, but are of secondary importance to its main purposes (hereinafter: “Neutral Assets”). In other words, the existence of movables used by the union to create income, or which are not of secondary importance to that union’s main purposes, shall remove the company from the “property association” definition.
Thus, in order to determine whether we are dealing with a property association, we must first locate the union’s assets, and then sort the assets and distinguish between them.
Secondary Discussion – Selling/ Purchasing a Hotel – is it an Action in a Property Association?
The main asset of an hotelier company is the hotel building itself. However, the furniture, the equipment and the facilities in the hotel are major income generator process of the hotel, whereas the assumption is that guests would not rent rooms if it not for those furniture and facilities.
It shall be noted that often, a company which owns a hotel, leases the hotel to external factors and/or binds in agreements for managing the hotel, when those agreements determine which assets (facilities, furniture and equipment) belong to the company and which belong to the external factors. Namely, it is not enough for the hotel to have furniture and equipments, it should be examined to whom they belong, to the company or to the external factor such as a lessee or a managing company.
In Ruling 38/07 by the Tax Authority, a transaction was examined, of a sale of shares by a company which holds a hotel which constituted 75% of its assets. The hotel was leased to an external factor, and the lease agreement stated, among others, that the investments for improving and renewing the hotel’s equipment and facilities shall be at the expense of the lessor during the lease term. In addition, it was stated that upon the end of the lease term, all additions and facilities in the hotel, even if installed by the lessee and at his expense, shall belong to the lessor.
The taxation committee ruled that the assets – facilities, furniture and equipment – serve for creating the hotel’s current income and are not of secondary importance to its main purposes and that these assets, in accordance with the lease agreement, belong to the company and not to the lessee. Therefore, the taxation committee has ruled that the company should not be regarded as a property association.
Can the rulings in Taxation Ruling 38/07 also apply in the case of a hotel which is under construction? In such a case, the union’s main asset (not to mention the sole asset) is a property asset on which a hotel is intended to be established. Usually, such a union does not hold, upon the occurrence of the tax event, furniture and equipment which serve it in creating its income, and if it already holds them, they are not used in creating its income upon the occurrence of the tax event. Therefore, a hotel under construction is likely to be considered as a “property association”.
The court has ruled on various cases, that if upon the execution of the transaction the company did not own additional assets, which will be added to the company in the future, it does not exclude the company from the definition of a property association. Accordingly, the Karni case was about a company which purchased a lot on which it was intended to establish a golf village which includes hotels, restaurants and such. The court ruled that the plan to establish a hotel project does not cancel the union being a “property association”, and that expected incomes in the company’s future are not considered as incomes related to by the definition of a “property association”.
Similarly, it was ruled in the Karfis case that the company (a construction company) should be classified as a property association whereas upon making the transaction, which is the time of the tax event, the company did not have additional assets.
One more thing taken into consideration is the worth of those assets which exclude the company from the definition of a property association (it appears that Neutral Assets or assets of secondary importance shall not be taken into consideration regardless of their worth). In various taxation rulings it is possible to see that the Tax Authority has adopted a rule of thumb, according to the worth of the assets – which exclude the company from the definition of a property association – should constitute at least 10% of the worth of the company’s assets.
In the last few weeks, two opposite rulings were given by the appeal committees which have discussed similar matters, raising parallel questions – are we dealing with an action in a property association.
The RothchildShopping Center case – a company which holds the RothchildShopping Center has allocated shares to another company, granting it 99.9% of all rights in the company. the questions faced by the court were: (1) does the action of allocation meet the exclusion conditions set in the Law (see for this matter the definition of an “action” in this article above) and (2) is the company a property association.
Regarding the classification of the company as a property association, the question was examined, whether intangible assets, such as reputation, constitute Neutral Assets or assets which exclude the company from the definition of a property association. The court has examined the definition of “movables” in the Interpretation Order (New Version), where movables are defined as: “tangible assets, apart from land”. The taxation committee has ruled that in accordance with the wording of the law, and in the absence of a Supreme Court precedence on the matter, the mere existence of intangible assets in the union, be of secondary importance as they may, are allegedly sufficient in order to exclude the company from the definition of a property association.
The court has ruled that since the company has proven the existence of intangible assets upon making the transaction, the company should be excluded from the definition of a property association.
The Hutzot Ha’Mifratz Shopping Center case – a company which holds the Hutzot Ha’Mifratz Shopping Center sold its shares to another company. The question discussed once more, was whether this was an action in a property association.
The company argued that upon making the transaction it had intangible assets, such as: the right for providing management services to the lessees, the right to sell electricity, a collection of clients, knowledge in shopping center management, a brand name and human capital. The company further argued that the worth of the intangible assets constitutes more than 10% of the worth of all of the company’s assets.
The court has not accepted the company’s arguments and ruled that the aforementioned assets should be regarded partly as Neutral Assets, such as: the brand name and knowledge in shopping center management, and partly as assets which are of secondary importance to the union’s main purposes, such as: the right for providing management services to the lessees and the right to sell electricity.
Contrary to the ruling in the Rothchild case, that intangible assets are not entered into the definition of movables, therefore constituting assets which exclude the company from the definition of a property association, in the Hutzot Ha’Mifratz Shopping Center case it was ruled that even if the union is found to have intangible assets, these should be examined as to whether they are Neutral Assets, assets of secondary importance or whether they are fundamental assets which are used by the union for creating income.
The definition of a property association in the Land Taxation Law generally, and the issue of which assets shall be classified as Neutral Assets specifically, are inconclusive, and the classification as stated is subject to the interpretation of the courts. As is evident in the two rulings given in the RothchildShopping Center case and the Hutzot Ha’Mifratz Shopping Center case, the appeal committees have provided different interpretations to the companies’ assets, and the outcomes of the rulings were opposite. It seems that indeed that Supreme Court shall have to determine which assets shall be considered Neutral or of secondary importance, and which assets shall exclude the corporations holding real-estate assets from the definition of a property association.
 The Land Taxation Law in its original version from 1949 imposed a tax debit only in the case of selling and purchasing rights in land, which encouraged assessees to perform actions in land indirectly by purchasing or allocating shares in a limited company which holds the land (for example block/lot companies) thus avoiding paying the land taxation. In order to avoid the loophole in the Law, the Land Taxation Law was amended in 1963 and stated that land taxation will also apply in the case of an action in a property association.
SeeLand Taxation Instruction for Execution no. 9/2008.
 Appeals Committee 1429/08 Gazit Globe Israel (Development) Ltd. vs. the Land Taxation Office Manager in Rehovot.
 Appeals Committee 1027/01 Karni Oded et al. vs. the Land Taxation Manager in Be’er Sheva.
 Appeals Committee 6006/06 David Karfis vs. the Land Taxation Manager in Hadera
 See Taxation Ruling 42/07; Taxation Ruling 4253/11; Taxation Ruling 5687/12/