Transferring a residential property between relatives free of compensation, is still considered a “real-estate transaction” by Israeli law.  This status remains even when the real-estate was gifted and  transferred without the “seller’s” receiving any consideration for it. The Law defines who is considered a relative for the purpose of gifted transactions, and these transactions are granted tax benefits.

Anyone purchasing residential real-estate in Israel is liable to pay purchase tax, in accordance with the tax brackets set by the Tax Authority. This tax is paid directly to the state for purchasing real-estate in Israel, where the tax rates will vary and depend on the type of real-estate purchased. As of the year 2020, Israeli residents who purchased their family’s sole residential property are exempt from paying sales tax for purchases that are valued up to 1.74 million NIS.  Purchases made valuing above that are entitled to be taxed at reduced tax bracket rates.

When an Israeli resident purchases another residential property other than his own, they have the option to request that they will be taxed as if they are a single property owner, provided that they declare to the Tax Authority that they undertake to sell their first property within 18 months of the singing of the purchase of the new property, and of course provided that they do infect succeed in selling the first property.  This gives the property owner the benefit during this 18-month period – the overlap period – of actually owning two assets however for the intents and purposes of the Tax Authority the second asset is viewed as the only property in their possession.

Noga and Haim Shamrat lived in the sole property in their possession, a house in Korazim. In 2015, they bought a house in Tivon and were supposed to sell their home in Korazim to finance the purchase of their new home. After they were unsuccessful in selling their home in Korazim, they decided to transfer the house in Korazim instead as a gift to Noga’s mother, and they did so on the last day of the overlap period – the period of time which they undertook to sell their old house so that the purchase tax on their new home would be calculated according to the tax brackets of a sole property.

The Tax Authority has determined that the gift transaction was an artificial (fictitious) transaction and determined that the couple must pay purchase tax in accordance with the applicable tax brackets applied to individuals purchasing a second property.

An artificial transaction is a transaction that may be legal but is not legitimate in so far as the applicable tax considerations.  That is to say the boundary line between legitimate tax planning and improper tax planning is crossed, and each determination is made on a case by case basis.

The test in deciding such cases, as the one cited above was set out in the Supreme Court is the “Commerciality Test”; that is, whether the transaction is fundamentally and  economically justifiable at its core. In accordance with this test qualification, if a transaction has no other commercially justifiable reason other than tax evasion – it is viewed as an artificial transaction. The Supreme Court ruled that the Commerciality Test is not the only decisive test to determine an artificial transaction, and affirmed that all of the circumstances of the transaction must be examined and taken into account- for example:

What are the objectives of the transaction?

What are the reasons for the transaction?

Did the transaction have any economic or commercial advantages other than the evading taxes and what weight did those motives have in the decision-making process to complete the transaction?

When the Shamrat Couple purchased their new home, they stated that it was a second apartment and did not intend to sell their existing home. Four months later, they changed their mind and declared their intent to sell their first home. On the final day that they would be eligible to receive purchase tax benefits as sole property home-owners, they gifted the house in Korazim to Noga Shamrat’s mother. Also on that day Noga Shamrat’s mother signed a will, stipulating that with her passing, the house in Korazim would pass to the Shamrat couple.

Because the Tax Authority ruled that this was an artificial transaction, the matter was brought before the court in Nazareth, which issued a ruling in early February 2020.

The court ruled that the couple clearly gifted a house that would be returned to them in the will, all the while they would continue to enjoy the compensation for the rental of the house. The judge rejected the couple’s claims, that they gifted the house so that the mother would be in charge of the house’s sale or rent, because the mother’s age and the significant distance that her residence was located from the home. The judge also emphasized that even if she believed the couple maintained that they had requested assistance from the mother to manage the property, this would still not constitute a substantive reason for the gift transaction.

In addition, the couple failed to prove that they agreed with the mother that she would pay the mortgage payments of the house. The mortgage was not transferred in the name of the mother and they were unable to prove that the mother paid it or that she pledged to do so in exchange for receiving the gift in Korazim.

According to the court, the matter of the mother’s will also raised the suspicion that this is not a legitimate gift.  If it had not been written specifically that the house is to be returned to the Shamrat couple, it should in fact have been divided among all the heirs of the mother.

The court ultimately ruled that in light of all the circumstances of the case, the Tax Authority was correct in their determination that this was an artificial transaction whose purpose was tax evasion. The Shamrat couple were not able to meet the burden of proof and failed to prove that aside from the tax evasion, the gift transaction was commercially viable.

This ruling, in addition to a prior ruling which was given regarding Mr. Jacob Arbiv, in September 2019, indicates the Tax Authority’s growing trend to examine gift transactions between relatives, where the specific circumstances of each transaction are significant.  This even including noting the rent and who actually receives the rent, financial liabilities such as mortgage, timeliness, and more.

The decree in the case of Shamrat couple underlines the need to undertake an in-depth examination of the full implications and risks inherent in gift transactions between relatives.

(Appeal Committee 24989-09-18 Shamrat et al. V. Land Taxation of Tiberias et al.).