The Israeli Supreme Court has just ruled on the vexed question of what happens to tax losses of a deceased person. Does the next generation get to inherit those tax losses? The court ruled the answer is no (Tel-Aviv and Kfar Saba Assessing Officers and Gili Dinstein vs. Fabio Yehezkel Malecheson Engel and Irit Malechson, Civil Appeal 1579/29 handed down August 18, 2021).
This may seem puzzling because Israel repealed estate/inheritance tax in 1981. Instead, the recipient of an inherited asset steps into the shoes of the deceased and acquires the cost basis and purchase date of the deceased regarding the assets: real estate, securities, and so forth.
So why can’t the recipient inherit the tax losses of the deceased? And in the light of this decision, what action should now be considered by living Israelis and non-Israelis?
The main facts of the case
Zvi Dinshtein (dec’d.) died in 2012 with accumulated capital losses for Israeli tax purposes of around NIS 46 million, and business losses of around NIS 1.7m. Three heirs of the deceased tried to utilize losses of the deceased against income arising in 2012 and 2013 but their loss claims were rejected by the Israel Tax Authority (ITA).
The main issue
Is the utilization of losses for tax purposes a right the taxpayer has by law an immovable “personal right,” or is it realizable also by his/her heirs?
The Supreme Court decision
The District Court Decision already found that Section 28 of the Income Ordinance allows “the same person” to claim ordinary business losses that year against other income, while Section 92 allows “that person” who made capital losses to offset them against future capital losses. But the District Court found there was simply no section allowing heirs to use the tax losses of the deceased.
The Supreme Court reviewed the case at length and came to the same conclusion. The court noted that likewise, in most other countries reviewed, losses cannot be inherited by the heirs.
“The desire of the tax system is to reward business owners who invest and take a risk, by enabling them to utilize losses that arise now against future income of theirs after their investments bear fruit, doesn’t imply that the tax system is interested in granting this benefit to another person such as an heir – a person who merely enjoys the benefit without taking the aforesaid risk” (Para. 30).
THE COURT noted that buying a company for its losses could be criticized as being artificial. Losses also cannot be carried back in Israel. The ability to utilize losses for tax purposes is a personal right that cannot be directly transferred directly to someone else and cannot be bequeathed (Para. 31). It is a non-property right that cannot be expressed monetary terms, like a personal right (Para. 32). The right to make use of losses for tax purposes accrues to the taxpayer personally and sharing losses among various taxpayers is not permissible (Para. 35). The tax rules do not in principle allow the right to be transferred for the good of the public purse (Para. 37, 38 & 46).
Comments - possible action to consider
Now Supreme Court has finally decided – Israeli tax losses cannot be inherited – any Israeli or non-Israeli individual with Israeli tax losses should take action to use them while they still can, in their lifetime.
What follows is not advice, we briefly mention a few non-exhaustive general points. Consult experienced tax advisers in each country about specific cases.
First, consider selling assets to a third party in your lifetime to generate a capital gain that can be offset against the tax loss. In the case of securities, could there be a sale and repurchase of similar or dissimilar securities to harvest gains – a “bed and breakfast”?
Second, consider selling assets to a related company at a fair market price. Note, however, that the District Court has ruled that a sale of foreign intellectual property by an immigrant to his own Israeli company may be considered artificial or fictitious and the ten year tax Israeli exemption does not apply (Sephira & Ofek Ltd and Amram, 2995-03-17 etc. August 16, 2021).
Third, consider selling an asset at an arm’s length (market-based) price to a foreign resident beneficiary trust, but not an Israeli residents’ trust nor a testamentary trust, all as defined in the Israeli Income Tax Ordinance. Numerous conditions apply and the process is irrevocable (non-cancelable).
Fourth, is a financing/refinancing and distribution a worthwhile possibility? Not always.
The writer is a certified public accountant and tax specialist at Harris Horoviz Consulting & Tax Ltd. leon@h2cat.com