The Bottom Line: The District Court rejected the appeal of LLD (of the Lev Leviev Group) and ordered it to pay tens of millions of dollars in capital gains tax regarding the sale of its holdings in American corporations. The Court ruled that although the sale of rights was formally executed by a foreign company (LGC) established as part of a restructuring, LLD (the Israeli company) remained the assessable entity liable for tax, in accordance with the Tax Ruling signed with the Israel Tax Authority. The judgment clarifies that tax rulings are a binding "package deal"—one cannot enjoy the tax benefits (tax deferral) while disregarding the restrictive conditions attached to them.
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Summary of Key Determinations

• Status of a Tax Ruling: A Tax Ruling Agreement is a binding contract. A taxpayer who enjoyed tax deferral by virtue of the ruling cannot retrospectively claim that its conditions (such as the identity of the taxpayer or a prohibition on foreign tax credits) are illegal.
• Identity of the Assessee: Even if the asset was formally sold by a foreign company (LGC), the Tax Ruling explicitly stated that the Israeli LLD would remain responsible for the tax payment to prevent assets from escaping the Israeli tax net.
• Timing of the Tax Event: The tax will be imposed on a cash basis (at the time the funds were actually received), rather than at the time of the legal event, due to the uncertainty regarding the final consideration amount during the legal dispute.
• Transfer Pricing: The Court accepted the company's appeal regarding transfer pricing and canceled an assessment based on general statements made during a police investigation, which lacked economic basis or market research.
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Background of the Dispute

LLD, a company in the diamond industry, held rights in American corporations (LLCs) through British Virgin Islands (BVI) companies. In 2006, the company performed a Restructuring with the approval of the Tax Authority: it transferred holdings to a new American company (LGC) with a tax exemption (tax deferral), subject to conditions set in a "Tax Ruling Agreement."
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Years later, a dispute erupted between LLD and its American partners (the Klein family), leading to the sale of the rights in the corporations. The Assessing Officer issued an assessment to LLD for capital gains from the sale based on the Tax Ruling.
LLD argued that the seller was the American company (LGC), and therefore the Israeli company should not be taxed, and that, in any event, taxes paid in the US should be credited.
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The Legal Issue

The appeal dealt with three weighty taxation questions:

1. Validity of the Tax Ruling: Can a Tax Ruling "override" general law and determine that an Israeli company pays tax on the profit of a foreign company, contrary to the principle of separate legal personality?
2. Timing of Tax: Does the tax event occur at the time of "exit" from the partnership (2013), or only upon the conclusion of legal proceedings and receipt of full consideration (2017)?
3. Transfer Pricing: Can a transfer pricing assessment (Section 85A) be based on the testimony of a former manager in a police investigation, without a comparative market study?
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The Court’s Decision

Honorable Judge H. Kirsch accepted the Assessing Officer's position on most substantive issues but accepted the company's position regarding transfer pricing.
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1. The Tax Ruling is Binding
The Court ruled that LLD cannot "have its cake and eat it too." It enjoyed tax deferral in 2006 thanks to the Tax Ruling, and therefore it is bound by the ruling's conditions, which stipulate that it remains the assessee for Israeli tax purposes even upon a future sale by the foreign company. It was determined that this arrangement was intended to prevent a situation where assets leave Israel tax-free.
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2. Prohibition on Foreign Tax Credit
The Judge affirmed the validity of the condition in the Tax Ruling which denies LLD the right to receive a credit for tax paid (if paid) in the US by the foreign company. It was determined that this is part of the "price" of the tax deferral to which the company voluntarily agreed.
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3. Cash Basis Taxation
On the issue of timing, the Court ruled in favor of the taxpayer. Given the uncertainty that existed in real-time regarding the amount of consideration (due to the legal dispute), it is correct to tax the gain on a cash basis—meaning, on the dates the money was actually received (2013-2014)—rather than on a full accrual basis in 2013.
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4. Cancellation of Transfer Pricing Assessment
On a separate issue, the Court criticized the Assessing Officer for basing an assessment of "inflated expenses" (purchase of diamonds from a related party) solely on a statement by a former manager during an investigation, without conducting an economic examination or price comparison. The assessment on this point was canceled.
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Practical Takeaways

• Tax Rulings are a "Binding Commitment": Before signing a ruling, one must understand the long-term implications. Waiving foreign tax credits or agreeing to the identity of the taxpayer are conditions that will bind you for years to come, even if general law changes.
• International Restructuring: Transferring assets to foreign companies (a "Flip") is a tax event. Tax deferral is possible, but the price is often "tethering" the asset to the Israeli tax net for the future.
• Transfer Pricing Documentation: LLD's victory on this issue teaches that the Tax Authority must present an economic basis for transfer pricing assessments. However, companies are advised to prepare a Transfer Pricing Study in advance to fend off future claims.
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FAQ

Q: Is an Israeli company liable for tax on the profit of a foreign subsidiary?
A: Generally, no (except for dividends or CFCs). However, in this case, the liability arose from a specific agreement (Tax Ruling) that the company signed as a condition for tax deferral in the past.

Q: What is "Cash Basis Taxation" regarding capital gains?
A: Usually, capital gains are taxed at the time of sale (accrual basis), even if the money has not yet been received. In exceptional cases of extreme uncertainty regarding the consideration, tax can be imposed at the time the money is actually received.

Q: Can a Tax Ruling be cancelled retrospectively?
A: It is very difficult. The Court clarified that a taxpayer who enjoyed the benefits of the ruling (tax deferral) is estopped from claiming against the legality of its restrictive conditions.

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