Horror movies reflect our worst nightmares. The Day of the Triffids and The Little Shop of Horrors were classic examples involving man-eating plants. For those of us who dream tax, there has always been ‘The Company that Purchased its own Shares’, not a Hollywood Blockbuster, but a Tax Brainbuster.
The plot is quite simple. A non-intelligent, inanimate independent being known as a ‘Company’ eats part of its own body known as ‘Share Capital’. The problem is that every time the directors, known as judges (not to be confused with Film Festival judges), try to come up with a standard denouement, they end up riding off on buy-back into the unknown.
In the absence of clear legislation on the issue of what to do when a company buys back shares from its shareholders disproportionately, the remakes have been running for decades including endings like: Dividends to all the owners before the buy-back of the shares, Dividends to the remaining owners after the buy-back of the shares, Economic purpose, and EVEN a simple capital gain for the shareholder selling out (the last being very boring and only to be considered when there really is no other narrative-ending alternative, such as selling shares in a public company ). In 2018 the Editors (in the guise of the Tax Authority) felt the need to finally get involved, although their Circular on the subject left the script pretty much scattered all over the cutting room floor.
Earlier this week the High Court dealt with appeals against two lower court judgments. And – maintaining the suspense – the subject that has been keeping us all guessing for years, is still keeping us guessing.
Among the court of 3 judges, the majority opinion was that, generally, in a private company, a disproportionate share buyback is effectively the distribution of a dividend to all the parties in the transaction followed by use of the funds received by the shareholders who are remaining to purchase those shares from the selling party. That is broadly in line with one of the two tax authority views back in 2018 (the other being that the remaining shareholders pick up tax on the entire value of the share buy-back as opposed to the relative amount of their holding before the transaction).
The trouble is, there was a lot of debate and real dissent. One judge wanted individual cases to be assessed according to the intentions of the shareholders – was the use of company funds, say, a convenient ruse to cover the shareholders’ obligation to buy the shares, or was there some real benefit to the company (that inanimate, self-eating entity)? He wasn’t happy that one of the main principles of taxation was being trodden on, that is that gains are only taxed when realized. To make things a bit workable, if not entirely palatable, he suggested a presumption that would be open to dispute by the presumed-against parties. The other justices hit back: If that approach were adopted, it would all end in tears (as Horror Movies generally set out to achieve), depending on how well the shareholders acted out their case. They simplified matters by generally restricting their application of dividends to partnership-like structures unless someone came up with an Oscar winning performance against. As was, however, pointed out, there is no such thing as a partnership-like structure in Israeli law – and Israeli courts are where Israel law is acted out – which required some clever plot-turning on the part of the bench.
Bottom Line – for anybody looking for precedent, this is a mess. (As an aside, when the transaction is international, the whole issue turns Netflix-worthy with tax escaping overseas). While the judgment might represent a new horror story with its own protagonists and antagonists, there surely has to be a better way to deal with this issue.
And there is.
After the governments of Ben Gurion down to Netanyahu inclusive have ignored the matter, would it be too much to ask that the Knesset take time out to legislate clearly on this important topic and let tax nerds go back to waking up in a cold sweat from dreams about being stranded on a Desert Island Permanent Establishment.