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            Taxation of Damages Received Under a Compromise (March 26th, 2009)

            1.Factual Background

            1.1The Corporation entered into an agreement with a number of land owners ("Owners” and "Land” respectively), pursuant to which the Corporation would increase the building rights on the Land in accordance with the City Zoning Plan ("Plan”) in consideration for an agreement with the Owners to be entered into thirty days after the increase in building rights pursuant to which the Corporation could build on the Land and the Owner could receive in return therefor completed apartments ("Combination Agreement”). The Combination Agreement was signed and held in escrow by the Owner’s attorney.

            1.2After several years, the increased building rights were granted.


            1.3The Corporation sued the Owners for the performance of the Combination Agreement. The court denied specific performance because the Combination Agreement had not been filed with the tax authorities and was consequently illegal.

            1.4On appeal a compromise was reached ("Compromise”) in accordance with which the appeal was denied, the Land was freed of the rights of the Corporation and the latter received due monetary compensation.

            2.Question Posed

            What is the character of the compensation for tax purposes?


            3.1After examining the relevant precedents, the general criteria used to differentiate between capital receipts and ordinary income and dwelling on the true economic substance of the underlying transaction, the opinion concluded that since the compensation was a one time lump sum amount that lacked periodicity; since the Combination Agreement founded a source of income (sale of apartments); and since the compensation was paid for the liquidation of the source of income or its sterilization, it was a capital receipt.


            3.2Should the Combination Agreement be held not to have been annulled for tax purposes the Corporation will be liable for Purchase Tax at 5% of the value of the land purchased by it in the combination agreement but on the other hand, it will enjoy a capital loss, which it will be able to set off against the compensation.

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