Contributed by Artzi, Hiba, Elmekiesse, Cohen - Tax Solutions Ltd, Israel

A judgment by the District Court in Tel-Aviv-Jaffa was published on the subject of an appeal by the Nawi Brothers Group Ltd. (hereinafter – The Company) against an assessment order, in which it was determined that the Company is not entitled to offset losses that had accumulated prior to its acquisition.


At the beginning of the year 2011, the Nawi Brothers acquired a shell type stock exchange company (by way of a private allocation of 85.5% against the injection of an amount of NIS 47 million into that company), which was "clean" (i.e., without assets or liabilities whose operations had been discontinued about half a year beforehand) which had approximately NIS 153 million of accumulated losses at the end of 2010 (approximately NIS 44 million in business losses carried forward and approximately NIS 109 million in real capital losses on securities carried forward) and new activity and profitability were transferred from a private company that they owned, in the field of deferred notes ("the discounting of checks"). In the years 2011 – 2013, all of the accumulated losses were offset against the Company's chargeable income from the discounting of checks.

The assessing officer based himself on a claim of artificiality, and using the special authority that is afforded to him within the framework of the general anti-abuse rules, he reclassified the transaction and determined that the accumulated losses (brought forward) cannot be offset within the framework of the Company's activity in the field of the discounting of checks.

It should be mentioned that after the assessment was issued under an order, a partial assessment agreement was signed with the assessing officer for the years 2011 to 2013 pursuant to which the offsetting of the real loss on securities (in an amount of approximately NIS 109 million) from the Company's chargeable income was cancelled, apparently because of the fact that they had not been offset from the Company's capital gains (which did not exist in those years) pursuant to the provisions of the Ordinance,  but rather from the chargeable business income .

As a rule, the Court determined that on grounds of the principle of justice in the imposition of tax, the legislator permitted the offsetting of losses against profits from different businesses owned by the same assessee (an individual or a company), however, "the watershed line in the implementation of this principle is that on the sale of control in a company to new shareholders, who have the ability to direct its operations and who have an economic interest in it". And therefore, the Court went further and emphasized regarding the acquisition of a company with accumulated losses: "…that the principle that prohibits the purchase of losses that have been incurred (indirectly) by other shareholders, only applies where there is no fundamental commercial ground for the acquisition of the control in the company and the transfer of new profitable activity into it. In other words, "the baby will not be thrown out with the bathwater" in every case, because" in light of this, there is nothing in the fact that the new controlling interests did not incur the losses that have accumulated in the company from the economic perspective and there is nothing in the fact that there is not necessarily a connection between the previous activity and the new activity that has been entered into it, in and of itself, that is necessarily enough to prevent the offsetting of the losses".

And therefore, the Court determined that: only in a case in which the control is sold in a company, without a fundamental commercial ground, apart from the desire to utilize the losses, distort the balance in the direction of the principal of the prohibition of the purchase of losses that have been incurred by the previous shareholders".

The Court went further and stated that it had indeed already been determined in a previous judgment that not every purchase of a stock exchange shell with losses is an artificial transaction and that one should even view the "public visibility" that is associated with a stock exchange shell as being a sort of "commercial ground" and in the appropriate circumstances, even a fundamental one. However, the Court determined that every case is to be determined on its own merits and in particular the issue of what the fundamental commercial ground that formed the basis for the acquisition of the specific stock exchange shell was.

The Court determined, that in order to negate a claim of artificiality of a transaction, one needs to weigh up the commercial ground and the fiscal ground therein, and to show that (at least at the level of a reasonable expectation) the transaction is accompanied by a fundamental commercial ground (where the burden of objective proof is placed upon the assessing officer), and at the same time it must also be shown that the importance of the fiscal ground in the transaction (i.e. the tax shield that is inherent in offsetting the accumulated losses, where the burden of subjective proof is placed on the assessee) is of a less fundamental level, and all this is to be measured and examined at the time of the execution of the transaction and not retrospectively.

And in brief, when operating the anti-abuse rules, the assessing officer has to be the first in order and to show that the transaction would not have been executed were it not for the tax advantage (the fiscal ground) and only if he succeeds in doing so is the burden on the assessee to prove (subjectively) that the transaction would not have been executed were it not for the commercial- economic ground therein.

Regarding the fiscal ground (the tax asset that is inherent in the losses), the Court adopted the assessing officer's figures, in the formula for the calculation (the level of the accumulated losses, the corporate income tax rate, the withholding rate in the Company – and all this as was seen at the time of the acquisition!), and reached the conclusion that its level was estimated at approximately NIS 34 million  (as compared with just NIS 9 million, as claimed by the Company), which the Nawi brothers hoped for and expected and which constituted a fundamental ground from their perspective at the time of the acquisition of the Company.

Regarding the commercial ground in a transaction and its real fundamental nature, the Company claimed and the Court agreed to this and went further that its activity in the field of discounting checks through a stock exchange company afforded that activity, which generally suffers from a negative image (the grey market), appropriate "public visibility", and numerous additional tangible commercial advantages, such as: an influencing customers to use the services of a supervised and audited public company, entrance to the Stock Exchange whilst turning "a new page" without exposing past results, the ability to raise credit from the banks with reduced guarantees, the ability to recruit credit from the capital market and increase the sources of financing, the ability to realize holdings readily and at high values and all this whilst retaining effective control in the Company. Furthermore, the entry into the Stock Exchange with an existing stock exchange shell reduces the Company's time-lines, efforts and costs significantly – which achieves the existence of the commercial ground.

Despite the aforesaid, and for the purpose of the examination of the commercial ground and the fundamental nature thereof, and even in the comparison to the fiscal ground, the Court went into the depths of the business decisions made by the Company and its controlling interests, which they saw at the time of the acquisition, and it examined the commercial grounds regarding the management of the check discounting activity in a public company (with accumulated losses) as compared with a private company (without losses for offsetting), what the commercial ground was in the entry to the Stock Exchange by means of a stock exchange shell by comparison with the alternative paths (such as: the acquisition of a listed public company, an initial offering of a private company and etcetera) and finally the Court also asked whether the Nawi Brothers made a commercial investigation of the acquisition of other stock exchange shells that were available at that time (for example, without losses or with smaller losses).

The Court reached the conclusion that in real time (at the time that the transaction was executed) the Nawi Brothers expected that they would achieve larger profits (regarding the offsetting of the losses), they did not expect to recruit equity in the first years (the issuance of the bonds only took place 4 years later) and also that: "in order to prove the existence of "a fundamental commercial ground" in the acquisition of the specific shell,  the Nawi Brothers had to prove that they took reasonable efforts to try to find additional shells, that did not have losses or which had lower losses, and that it would have been possible to purchase them in that same unique business structure". Hence, the result that the Court arrived as was that the acquisition of the Company was made for a fundamental fiscal ground of the utilization of the accumulated losses and therefore it was artificial.

In our opinion, the economic weighing up that the Court conducted in this case is a comparison between chalk and cheese. How is it possible to compare between a kilogram and a kilometre? The fiscal ground can be measured exactly and (relatively) easily in money terms, whereas the commercial ground and the fundamental nature thereof are examined and measured by a test involving common sense in accordance with economic, commercial, business and moral  criteria, market regulations and etcetera- how can we make a real examination of which of the foundations overrules the other? How many further rulings will be written in order to find the magical formula for this unknown? Therefore, maybe this is the place and this is the time to call in the legislator, out of an approach supporting tax stability and to set clear and absolute tax directives for situations in which a company cannot offset accumulated losses.

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