Liability of shareholders for tax debts of the Company

Liability of shareholders for tax debts of the Company

Written by

Tal Schiller
November 6, 2017

A client of our firm, a German businessman, invested a large sum of money to purchase 40% of the shares of an Israeli company, but the investment was unsuccessful and the company closed down. A few years later, the businessman was surprised to receive a demand to pay the company's city tax, even though the company was a limited liability company, and that businessman was not involved in its management. Can the authorities require an investor to pay debts of the company?
In corporate law there is a rule whereby under the limited liability of a company, the liability that can be imposed on the shareholders is limited by the amount they undertook to invest in exchange for their shares. However, when it comes to debt collection by the authorities, there are cases in which the tax authority or the local authority is entitled to demand payment of company debts from shareholders. Thus, for example, Israeli law enables in some cases the collection of a final municipal city tax of a private company from a controlling shareholder in respect of an asset that is not used for residential purposes. The authority's right is formulated only when the following alternatives exist: The company was liquidated or ceased operations without paying city tax (as distinguished from an active company with the means to pay the debt); The Company transferred its assets for no consideration or for a partial consideration and without any means remaining in Israel to settle the debt; or the company is liable for a final tax debt and transferred its operations to a group of persons who are is controlled by the same shareholders or their relatives.
While some are aware of the possibility for municipalities to collecting debts from controlling shareholders, not many are aware that the Israeli Tax Authority may similarly collect debts when a company is liquidated without paying its final tax debt to the Tax Authority. When a company transfers its assets for no consideration or in partial consideration, the Tax Authority is entitled to collect the tax debts of the company from the recipient of its assets. When a company is liquidated, the Tax Authority is entitled, in certain cases, to deem the assets that the company had as if such have been transferred to its controlling shareholders without consideration, and the company's tax debt may be collected from them.
Regarding the obligations of controlling shareholders to the tax authority or the municipality, the term "controlling shareholder" is defined in the Income Tax Ordinance in a very broad manner, including the holding of 25% of the means of control in the company, alone or together with relatives (a broad definition that also includes second-degree family members or a company in which family members hold 25% of the means of control therein), and the term "means of control" are also broadly defined as including not only voting power but also the right to acquire shares, the right to receive profits or the right to appoint a manager.
In view of the above, one should ensure that in investing in a company one does not cross the threshold of 25% of the means of control, unless one has the ability to ensure that the company pays its taxes to the tax authority or the municipality, and it is certainly important to consult professionals with knowledge in the field in order to reduce risk and exposure.