When is legal Israeli tax planning illegitimate?

you. Many other countries have similar but not identical rules. This case summarizes for us what is legitimate Israeli tax planning and what isn’t.

Calculating taxes (photo credit: INGIMAGE)
Calculating taxes
(photo credit: INGIMAGE)

The Israeli District Court has just clarified a High Court ruling on artificial or fictitious transactions under Israel’s general anti-avoidance rule (GAAR) in Section 86 of the Income Tax Ordinance (Spector vs. Large Enterprises Assessing Officer Civil Appeal 5366-05-20 of December 7, 2022).

If the Tax Authority (ITA) invokes GAAR, you are in trouble as the ITA may ignore the transaction(s) in question and tax you accordingly. This is the ITA’s way of saying that even if your tax planning is legal, it doesn’t look legitimate to them and they certainly don’t want other taxpayers to copy you. Many other countries have similar but not identical rules. This case summarizes for us what is legitimate Israeli tax planning and what isn’t.

What does Section 86 say?

An assessing officer may disregard a transaction, act or endorsement and assess tax accordingly if he believes that such a transaction or act that reduces or may reduce the amount of tax payable is artificial or fictitious, or such an endorsement is not really carried out, or that one of the main aims is tax avoidance or improper reduction of tax.

The Spector Case main facts: In this case, the taxpayer personally acquired shares in a fire-fighting related company, Spectronix, based in Sderot, over a number of years. In December 1999, he transferred his shares, worth NIS 49 million, to a holding company he owned, in return for a loan note. In 2015, there was an exit deal, in which the Emerson group acquired Spectronix. The taxpayer claimed a number of tax exemptions and reliefs:

House and calculator [Illustrative]. (credit: INGIMAGE)House and calculator [Illustrative]. (credit: INGIMAGE)

Exemption from capital gains tax on the transfer to the holding company under Section 21A of the Encouragement of Taxes (Industry) Law;

Exemption from tax on loan note repayments by the holding company to him out of tax-free dividends from Spectronix to the holding company out of profits;

Exemption for loan note repayments out of capital gains when Spectronix was acquired by the Emerson group in 2015.

Any remaining capital gain was shrunk by a stepped-up cost of NIS 49 million; Exemption from tax on inflation adjustment to the loan balance.

All these exemptions and reliefs were too much for the ITA. First, the Section 21A exemption was repealed as it allowed an unintended loophole. Second, the ITA raised the artificial or fictitious claims against those who tried it.

The Spector Case judgment:

The District Court ruled the transfer of shares to a holding company in the Spector case was indeed artificial or fictitious. But why?

The District Court drew heavily on an earlier similar High Court case (Gotshiel vs. Large Enterprise Assessing Officer, 1211/14 of November 11, 2015) without trying to distinguish any principles involved.

The High Court said tax planning is subject to a number of tests:

First, is the tax planning positive or negative? It is positive if the taxpayer acts according to the intended and stated basis of a tax relief, not a loop-hole the legislature (the Knesset) never imagined and would object to.

Second, is it artificial? An artificial transaction is one which lacks “fundamental commercial rationale.” Factors include the overall circumstances, reliability of the commercial rationale, economic considerations, economic substance and risk. The objective burden of proof is on the ITA and the subjective burden of proof is on the taxpayer.

In this case, regarding the first point above, the High Court found the tax planning was negative. The Knesset repealed the Section 21A capital gain provision, as it was only meant to exempt capital gains when an industrial company went public on a stock exchange, not dividends dressed up as loan payments.

Regarding the second point above, the High Court ruled the transaction (transferring shares to the holding company) was artificial, because the taxpayer failed to prove a fundamental commercial rationale. The taxpayer’s bank financed some of the purchase of the shares and apparently preferred a holding company, but no proof or reason for this was ever presented.

Also, the High Court ruled it was not too late to allege artificiality in 2015 regarding the share transfer to the holding company in 2000, because each tax year is separately assessable. So a separate “statute of limitations” clock runs for each year’s tax assessment.


Similar GAAR rules exist in the UK, Canada, Australia and elsewhere. The US has a sham doctrine. But the ITA and Israeli courts tend to interpret things more strictly. To sum up, the ITA plays hardball, so always have a fundamental commercial rationale.

As always, consult experienced tax advisers in each country at an early stage in specific cases.

The writer is a certified public accountant and tax specialist at Harris Horoviz Consulting & Tax Ltd.