• International Law office
    • Tax Notes International
      • BNA - Business Operations in Israel

        May 18 2012

        On March 29 2012 the Tel Aviv District Court ruled on the taxation of insurance compensation inTopap.


        The taxpayer's enterprise caught fire and a building and machinery were destroyed as a result. The assessing officer sought to tax the compensation received for the building and machinery as a capital gain, and that received to cover leasing expenses as ordinary income. The taxpayer contested the assessment, arguing that since no asset was sold a capital gain could not arise. Furthermore, the amounts received to cover leasing expenses were capital sums and hence not liable for tax.

        The question further arose as to whether the taxpayer was entitled to the benefits accorded to manufacturers during the tax year of the fire, in which all production was subcontracted to subcontractors due to a lack of production facilities.


        The taxpayer had contended, in respect of the capital gains assessment, that a capital asset was not disposed of as the building was reconstructed and remained in its possession. In short, the destruction of the building did not constitute its fiscal sale. However, the court rejected this argument. The definition of a 'sale' requires merely that the asset in "any manner whatsoever no longer be in the possession of the taxpayer". This definition is broad enough to cover the destruction of the facilities, since subsequent to this destruction, the taxpayer no longer possessed the facilities.

        The court was further required to clarify whether the building was an 'asset' for capital gains purposes. The taxpayer argued that had the building been sold, it would have been liable for tax under the Land Tax (Appreciation and Purchase) Law 1963 and was therefore excluded from the definition of an 'asset' under the Income Tax Ordinance. However, the court held that the compensation did not give rise to a liability for appreciation tax, as under the law no sale had occurred. Hence, the building was not withdrawn from the broad definition of an 'asset' for capital gains purposes and its 'sale' gave rise to a taxable capital gain.

        The court went on to hold that the fire was tantamount to the realisation of the machinery and building, and where such a realisation gives rise to a gain, the latter is taxable.

        As a rule, the profit derived from compensation is characterised in accordance with the subject matter thereof. Where capital assets - such as a building and machinery - are compensated for, the compensation takes the nature of the consideration received in a capital transaction.

        The taxpayer was compensated for leasing and other payments it incurred. The compensation received exceeded these payments. The court held the excess to be ordinary income because the payment was made to cover ordinary expenses incurred in the production of income. The excess could not transform into a capital receipt. The taxpayer's contention that the excess compensation should not be taxable, since the Income Tax Ordinance explicitly disallows the deduction of expenses that were recovered from insurance, was rejected by the court.

        Finally, the court decided that the taxpayer could not enjoy the benefits accorded to manufacturers under the Law for the Encouragement of Capital Investments 1959. As a result of the fire, the taxpayer lacked manufacturing facilities, and subcontracting was no substitute for these. The taxpayer therefore had no manufacturing activities, which were an essential condition to the granting of the tax incentives under the law.

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