TAXING THE TEL AVIV STOCK EXCHANGE -- BACKGROUND - 11-Sep-94

TAXING THE TEL AVIV STOCK EXCHANGE BACKGROUND

(COMMUNICATED BY GPO ECONOMICS DESK) Jerusalem, 11 September 1994

For the first time in forty-one years, investors on the Tel Aviv Stock Exchange (TASE) will be taxed on the profits on their investments. This decision was announced at a press conference on 16 August 1994 by Finance Minister Avraham Shohat and Bank of Israel Governor Jacob Frenkel. On 11 September 1994, the cabinet approved the proposed legislation.

The Government, they announced, had reached the decision to place a 10 percent capital gains tax on real profits from investments on traded securities including shares, warrants, and options. The decision, scheduled to go into operation on 1 January 1995, affects private, corporate, mutual fund, and foreign investor investments. Real profits on the sale of certificates of participation in mutual funds will be taxed at a rate of 15 percent, according to the regulations. Investments by provident funds, pension funds, and study funds will remain exempt from the tax. Taxes on investments by foreign investors will be determined in accordance with taxation treaties with other nations in order to prevent double taxation.

Due to the decision to tax profits on stock market investments, the Government ordered the exchange closed for two days in order to calm fears and allow investors, banks, brokers, and the economic community to digest the news and decide how next to proceed. On the first day of trading following the announcement, 21 August 1994, the market fell by approximately 10 percent as investors looked to dump their shares. Accordingly, the day began with some NIS1.15 billion in surplus sales requests in the Two-sided trading and NIS940 million in the computerized Karam trading. This was the first time the market had been closed since the Bank Shares Scandal of 1983 in which the TASE was closed for two weeks and four major banks (Hapoalim, Discount, Leumi, and Mizrachi) were nationalized.

A capital gains tax, though revolutionary in Israel, is standard in most developed and industrialized nations. The US and European markets all have a tax on capital gains, most at a higher rate than that proposed by the Government. Despite this, the announcement caught investors by surprise in view of Prime Minister Rabin and Finance Minister Shohat's previous statements.

Investments on TASE have been viewed by government officials as an attractive source from which to draw taxable income. Over the years, there has been speculation from various sources involved in the capital markets regarding the Government's intention to tax this income. However, until now, the Government had decided not to adopt this tax due to its political price and the difficulty of actually collecting the tax.

Taxation of real profits profits on investments after taking inflation into account from TASE investments will allow the Government to reduce taxation in other sectors, said Shohat. During the same press conference he and Frenkel also announced the liberalization of a number of foreign currency regulations, a reduction on indirect taxes, and a reduction in National Insurance Institute (Bituach Leumi) employer taxes.

On 21 August 1994, after protests from certain elements of the business and investment communities, the Government amended its decision to tax real profits by raising the option of offsetting losses against taxable income. On 4 September 1994, Shohat announced that investors choosing the offsetting losses option would be taxed at a rate of 20 percent. The Finance Ministry decided not to tax government bonds following Attorney-General Michael Ban-Yair's opinion that these bonds are protected from taxation under the Protection of the Public's Investments in Financial Assets Law.

Frenkel explained that the decision to adopt a capital gains tax on TASE investments was the natural result of the accumulation of a number of positive economic trends which the country has experienced over the past few years. Steady growth, expanding employment opportunities, reduced actual unemployment, improved competitiveness of local industry against foreign producers, as well as exposure of the local market all point to a healthy economy able to support a tax on bourse investments.

A factor contributing to the Government's decision to adopt the tax now has been the market's growth over the past four years. In 1990, 292 firms were publicly traded. This figure rose to 306 in 1991, in 1992 to 396, in 1993 to 573; by the end of July 1994, some 625 firms traded shares publicly on the TASE.

Market indicators have also risen steadily over the past few years. Market capitalization in 1991 was NIS99.8 billion, while in 1992 it rose to NIS166.6 billion. In 1993, market capitalization grew to NIS246.3 billion while in the first six months of 1994 it rose to NIS187.4 billion.

The annual trading volume of shares and convertible bonds (including bank shares) on the market came to NIS31.41 billion in 1990, while in 1991 it was NIS43.6 billion. In 1992, the trading volume of shares and convertible bonds amounted to NIS61.6 billion, while in 1993 it increased by 76 percent to NIS108.5 billion. During first six months of 1994 trading volume was NIS59.5 billion.

The real annual yield of the general share index rose by 37.1 percent in 1991, 75.2 percent in 1992, and 26.7 percent in 1993. For the first seven months of 1994, the yield of the general share index fell by 37.8 percent.