One development stems from the controversial Israeli Supreme Court Decision in the Sadot Case. The majority of the Court concluded that when partners transfer their business’s assets to a new corporation, the transfer should be considered as a sale of one capital asset – the share in the partnership, and not sale of each of the different assets, including inventory, and liabilities.
The article shows that the emerging theory that underlies the Sadot’s decision is quite far reaching. It opens new opportunities for tax planning, which seem to undermine the Income Tax Ordinance's (ITO) principles, purposes, and the legislature’s intention.
The other development already took place in the tax reform of 2003, when the Capital Gains tax rates have been reduced significantly. The lower rates require a most careful calculation and consideration regarding the advantages that are offered by secs. 104-104H of the ITO. Those sections allow the individual taxpayers to elect capital tax deferral when transferring their business assets to the new corporation created by them. A careful analysis reveals that such an election contains a built-in double taxation: the original purchase price of the transferred asset is carried over to the corporation and it is also allocated to the corporate's shares the taxpayers receive in the exchange. I use five different cases which demonstrate that the advantages to both the individual taxpayers and the corporation are doubtful. A careful tax planning should consider the magnitude of the deferred capital gain, the annual depreciation deductions of the transferred assets, the market interest rate, and the anticipated holding period the taxpayer intends to hold the shares.
The last part of the article discusses again the Sadot case and the unusual opportunities it opens for tax planning. A consistent application of the case may lead to a situation where a partnership which is loaded with ordinary income and large amount of capital gains will be allowed to "launder" and completely wash the income and gains into a insignificant amount of capital gain; a result that no doubt contradicts the goals and the purposes and the principles of the Israeli income tax system