How the Sale of Property by a Real Estate Expert May Indicate Business Activity

When real estate is sold by an experienced, active party in the property market, the transaction may be viewed differently from a simple one-time sale by a private investor. Even if the asset was held for many years without development, the seller’s expertise, familiarity with the market, and the structure of the sale can lead tax authorities to classify the transaction as business activity rather than a capital realization, with significant income tax and VAT implications.

The doctrine established by the Israel Supreme Court and reiterated in several significant rulings sets out 10 tests to examine a transaction and determine whether it has a commercial character. If it does, it will be taxed as ordinary income under the Income Tax Ordinance (as a business or an occasional transaction). If it is capital in nature, then when it concerns real estate, it will be taxed under the Real Estate Taxation Law.

In simple terms, the question is whether the sale is considered part of an ongoing business activity — which generally results in different and sometimes higher taxation — or whether it is the sale of a long-term investment asset, which is taxed differently.

It should be noted that these tests are also used by the VAT authorities when deciding whether a person or company should be registered as a “dealer.” The ruling in CA 111/83 Almor Management and Trust Ltd. v. VAT Director determined that the term “business” in the VAT Law should be interpreted in line with income tax law, using the same tests that distinguish between capital income and ordinary income.

It must be clarified that, as a rule, the determination of whether a transaction is ordinary (business) or capital (investment) in nature does not rely on just one test. Instead, the court considers the cumulative weight of all the tests. This is a substantive examination of the “overall picture,” meaning the court reviews all relevant facts and circumstances and assesses how they fit together, with particular emphasis on the final test—the circumstances test.

Two weeks ago, a judgment was issued in VAT Appeal 21734-11-22 Nof Na’eh Block 7650 Raanana Ltd. v. VAT Director Netanya, which held that the sale of real estate constituted business activity, even though most of the tests examined by the Court did not point toward business activity carried out by the company.

In the case at hand, during the 1940s and 1950s, the late Ms. Tzipora Chabas acquired rights in real estate in Raanana, and in 1962 transferred them to the Company (hereinafter: “the Company”). Since the Company’s establishment, its shares have been held by the Chabas family, who are undisputedly active in the real estate sector and have conducted numerous transactions through several companies in the past.

However, with respect to the properties in question, the Company carried out no development, improvement, or entrepreneurial activity since their acquisition. It simply held the land as an asset for many years. As a result, it did not register as a “dealer” for VAT purposes.

In 2016, a new plan was approved that changed the land’s zoning designation from agricultural to residential construction. Following this zoning change — which significantly increased the land’s potential value — the Company, through a broker, entered into an agreement with a real estate developer. The developer organized groups of buyers, each of whom acquired a portion of the land from the Company. Over a period of 13 months, the Company sold land to 80 purchasers, in 15 transactions carried out on seven different dates.

The Company properly reported the sales to the Real Estate Taxation Director in Netanya. However, six years later, the VAT Director issued a decision requiring the Company to be registered as a “dealer” in respect of these 2016 transactions. According to the VAT authority, the large number of transactions within a relatively short period indicated business activity subject to VAT.

The Court first explained that the fact that the Company did not initially register itself as a “dealer” is not decisive, since registration is merely declarative. In other words, whether or not the Company is registered does not determine its true legal status.

On the merits, the Court examined the tests established in case law and reached the following conclusions:

1. The holding period test – the land was held for a very long period, which generally indicates a capital (investment) nature.
2. The improvement test – the Company carried out no improvements to the property, again pointing to a capital nature.
3. The financing test – the Company took no loans to finance its activity, which also supports a capital characterization.
4. The nature of the asset test – although the property was not a private apartment, it appeared to have been acquired as a long-term investment by a company accustomed to purchasing land; therefore, this test was considered less decisive.
5. The organizational mechanism test – it was not claimed that the Company had a dedicated mechanism solely for this activity, nor did it conduct independent marketing efforts. However, it was assisted by an accounting firm that also handled the activities of other Chabas group companies, and therefore, this test was also considered less decisive.

Despite the above, the Court ultimately tipped the scales and determined that this was business activity, based on the Company’s satisfaction of only two tests: the frequency-of-transactions test and the expertise test.

The Court held that selling land to 80 purchasers over 13 months, through 15 transactions conducted on seven different dates, constituted a high volume of transactions within a short timeframe. The Company’s experience in the real estate field enabled it to structure sales efficiently and maximize profit by selling the land in separate parcels to different purchasers. It even increased the price by 18% during the sales process and passed the full betterment levy on to the purchasers.

According to the Court, this pattern of conduct reflects a well-organized and professional approach typical of business activity in the real estate sector. The Court therefore concluded that the VAT Director was correct in determining that the activity constituted business activity.

In my humble opinion, and with all due respect, the Court’s conclusion in this case — which relies on only two out of ten tests, while most of the other tests point in the opposite direction — does not align with the Supreme Court’s rulings over the years, which have generally emphasized the cumulative weight of most of the tests in determining whether activity is business or capital in nature.