Lior Pick, Adv, CPA (Isr.), TEP

The Jerusalem District Court recently discussed the question of the time in which capital loss is generated due to non-repayment of a shareholders loan that were made and the realization of a guarantee that was provided to an affiliated company, which was realized by its creditors (banks)?

In the judgment, the appellant held 25% of the shares in company A and company A held 25% of the shares in company B. In addition, the appellant also held shares in Company C. over the 90’s, the appellant attached 50% of his shares in company A to banks that provided financial accompaniment to company C’s activities.

Company A decided upon voluntary liquidation in 2000 and was liquidated on May 31st 2000.

In 2000, the company A shares, that served as guarantees for the repayment of company C’s debts, were replaced with cash that was deposited and pledged to that end.

The appellant claims that the respondent had to recognize the capital loss he generated as early as 2000 due to the loss of control of the consideration due to the shares to the banks. He claims that it was possible to deduce that a capital loss was about to be generated for him once company C became insolvent, meaning before 2000, and there is no need to wait for the capital loss to be realized in practice and in a final, ultimate manner.

Section 88 of the Income Tax Ordinance defines a “sale” for capital loss/gains purposes as follows:

“Sale – includes exchange, renunciation, disposition, transfer, grant, gift, redemption and also any other act or occurrence in consequence of which the asset passes out of the control of a person.”

The District Court determined that in light of the law’s demand upon the occurrence of a “sale” event, the appellant had to show that the asset was no longer in his possession in 2000 to be able to report of a capital loss for this tax year.

Meaning, a “sale” occurs once an asset somehow passes out of the person’s possession. This definition does not mandate that the asset reach somebody else. For example: a taxpayer who abandons his asset to the public will be considered to have sold it for the purposes of section E of the Ordinance.

In this case, the Court determined that one cannot determine that the appellant already accepted the final loss of company C in 2000, and so the fact that he transferred the consideration amount to the bank that year as an attachment or as loans to company C does not constitute a waiver of these funds.

The deposition of the shares and the deposition of the consideration in the bank did not result in the appellant’s capital loss in 2000; this was merely an event of changing guarantees, from shares to funds. The guarantee was not realized in 2000 and the appellant did not “give up” an “asset” he owned that year.

The appellant claimed that the capital loss event date is determined according to the event of selling the shares and depositing the funds in consideration thereto, to enable company C’s operation. However this claim is inconsistent with the rule that mandates profit realization as a condition for rendering it taxable in the court’s opinion. Consequently, a loss may also not be acknowledged and taxed before it is realized.

We will be at your disposal to provide clarifications on this matter and in general.

Our firm specializes in legal and tax counseling for companies and individuals in the fields of taxation, hi-tech and investments, in Israel and abroad.

Do not transfer and/or distribute that said in this circular to any party other then the party to whom the circular is addressed. Do not copy and/or photocopy and/or use this circular in any way without permission in advance and in writing from the undersigned.

This circular is general. Do not use that said in the circular in any way without receiving an opinion and/or particular professional legal counseling according to the specific circumstances.

Respectfully,

Lior Pick and Co., Law Firm.