Dear Clients, Colleagues and Friends,
The Income Tax Regulations (Rules for Calculation of Tax in connection with the Holding and Sale of Participation Units in an Oil Exploration Partnership) of 1988 (the “Petroleum Partnership Regulations“) establish and clarify the rules for calculating the tax due to the holding and sale of participation units in an oil exploration partnership. These regulations were originally introduced as temporary regulations which were extended from time to time. A number of amendments to said regulations are now proposed as discussed in more detail in this client update.

As a general rule, taxation of partnerships in Israel is based on the so-called “mixed method”. Under this method, the current income and expenses of the partnership are attributable to the holders of rights in the partnership (i.e., the partnership is treated as transparent for tax purposes). On the other hand, rights in a partnership are regarded as independent assets for tax purposes, and upon their disposition, are taxed in a manner similar to the taxation of shares of a company.

Under current law, in parallel to the Petroleum Partnership Regulations, Income Tax Order (Types of Partnerships that are Treated as Companies) of 2017, stipulates that a partnership listed on a stock exchange (except for a “partnership” as defined in the Petroleum Partnership Regulations), which conducts a business of oil exploration, development or production, will be taxed in a manner similar to the way a company is taxed. That is, oil partnerships (as defined in the Petroleum Partnership Regulations) are taxed pursuant to a “one-stage” taxation, while other oil partnerships that do not meet such definition are taxed in a manner similar to a company, based on a “two-stage” taxation principle, i.e., when the partnership generates income, there is an entity-level tax, and when the partnership distributes funds to its rights holders, such holders are subject to tax on the distribution as if it were a dividend.
Under the proposed amendments, an oil partnership the units of which are listed for trading on a stock exchange would be subject to tax based on a “two-stage” taxation principle, beginning from the tax year in which it generates taxable income or makes distributions to its holders. A partnership that is taxed pursuant to the two-stage principle is called a “closed partnership”. This proposed amendment is primarily for administrative optimization purposes.

In addition, the proposed amendments to the Petroleum Partnership Regulations introduce technical rules for purposes of calculating the tax upon the disposition of units in oil partnerships. Under the proposed amendments, these regulations would take permanent effect.

The Petroleum Partnership Regulations expired on June 30, 2015 and were not extended since. The proposed amendments would extend the validity of the current regulations retroactively from their expiration date, and the Petroleum Partnership Regulations, as amended, would apply starting from the 2021 tax year.

We would be happy to assist you with any additional information or inquiry you may have in this respect.

Sincerely,

The Tax Department

Herzog Fox & Neeman