Which exchange rate applies to an M&A deal?

Many M&A deals are denominated in foreign currency, but Israeli tax reporting is done in shekels.

Illustrative photo of Israeli money (photo credit: MARC ISRAEL SELLEM)
Illustrative photo of Israeli money
(photo credit: MARC ISRAEL SELLEM)

The Israeli Supreme Court recently ruled that the exchange rate on the date when an M&A deal (merger and acquisition, or “exit” deal) is considered done is the one that should be used to report the deal for Israeli capital-gains tax purposes.

Background: The shekel has its ups and downs, so exchange rates matter. Many M&A deals are denominated in foreign currency, but Israeli tax reporting is done in shekels. Capital-gains tax is reportable and payable within 30 days of the transaction, but when is that?

And what happens if an Israeli taxpayer sells shares at a price fixed in US dollars (or another foreign currency), but the exchange rate moves in the time gap between signing a sale agreement and the closing date? Such time gaps are very common and may be due to the due-diligence process, getting governmental approvals, board approvals, shareholders’ approvals, etc. Surprisingly, the issue has been uncertain until now.

The Shpunt Case

Alexander Shpunt was a founder of Primesense Inc., a US corporation that owned Primesense Ltd. of Israel, a video-sensor hi-tech group. On November 21, 2013, Apple Inc. acquired the group for a reported $360 million. The deal closed two weeks later on December 5. Shpunt sold 125,860 shares for $4,198,015. On December 9, he duly reported his gain for Israeli capital-gains tax purposes.

 Illustration of a sign leading to the Tax Authorities offices in Jerusalem.  (credit: FLASH90) Illustration of a sign leading to the Tax Authorities offices in Jerusalem. (credit: FLASH90)

The Israel Tax Authority (ITA) assessed him to tax in shekel terms at the shekel-dollar exchange rate prevailing on the signing date (November 21), which was 3.5629. Shpunt said the exchange rate of 3.524 that was prevailing on the closing date (December 5) should apply (i.e., fewer shekels).

The court ruling

The Supreme Court ruled that the transaction date for tax and exchange-rate purposes should be the date on which all requisite organs required by law have approved the deal, whichever is latest.

In this case, that was the date on which approval for the transaction was obtained from the company’s board and general shareholders, including meetings of each company regarding the M&A deal, whichever was latest.

Comment: Now we know which day’s exchange rate to apply when reporting transactions denominated in foreign currency for Israeli tax purposes.

There were some secondary issues. Shpunt elected to spread his gain over the last four tax years for tax purposes, apparently hoping to avoid an Israeli surtax (now 3%). But the court ruled that the surtax could not be avoided this way based on what the law said.

Last and least, the ITA tried to argue that the principles of Tax Circular 19/2018, regarding delayed consideration payment, should apply. The District Court pointed out that a circular dated 2018 could not possibly have been discussed by the parties in a case dating back to 2013!

Treaty shopping shot down

The term “treaty shopping” means using a company that just happens to be incorporated in a country that has a favorable tax treaty with another country, such as Israel.

In a recent District Court case, a BVI (British Virgins Island) company with a branch in Israel was owned by a BVI parent company, which in turn had various shareholders (Berggruen Holding Ltd. vs Gush Dan Assessing Officer Civil Appeal).

The Israeli branch operation was financed by a loan of nearly NIS 160 million from the BVI parent company. In June 2009, the BVI parent company assigned the loan to an affiliated company in Luxembourg. The Israeli branch operation paid virtually no interest on the loan before 2015. In 2015, it paid accumulated interest and tried to invoke Israel’s tax treaty to reduce the Israeli withholding tax on interest to 10%, instead of 23%-25% (generally) had the interest been paid directly to the BVI parent company.

The ITA argued there was no commercial reason for interposing a Luxembourg lending company apart from improper tax reduction. The taxpayer countered in court that Israel’s general anti-avoidance rule against artificial or fictitious transactions (ITO Section 86) places the onus of proof on the ITA.

The District Court concurred that the burden of proof of an artificial or fictitious transaction indeed lies with the ITA – but only after the taxpayer answers some important questions. Which company ultimately bore the loan risks and rewards – the Luxembourg company or the BVI parent company? Was there a back-to-back arrangement between them?

Comment: We don’t yet know the outcome, but treaty shopping is liable to be challenged.

As always, consult experienced 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.