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After four and a half months it is clear that the implementation of the tax reforms did not cause a shake-up of the capital market. Low trade volumes in the early months of 2003 increased with sharp rises in share prices. Most of the prophecies of doom regarding the collapse of the stock and derivatives markets did not come true. Everyone now agrees that the main factors affecting activity on the bourse are not related to the tax regime, but rather to macro matters.

It is difficult to isolate the effect of the tax reforms on trade at the Tel Aviv Stock Exchange from other outside causes. It is however possible to identify a steady increase in trade volume in all instruments. Some of the recovery in volume can be attributed to the market's assimilation of the reforms. Even the trade in derivatives, which suffered more in the beginning, has recovered somewhat. Nonetheless, trade in this area has not yet returned to its 2002 levels.

"The market's power is greater than any other economic factor," says Meitav CEO Tzvi Stepak, "and when investors see that they can make a profit, they forget everything else." Stepak says that the low point reached by the bourse in January-February was caused by economic and political factors as well as by the reforms. "With the elections over, and the previous finance minister and Iraq behind us, the way has opened for recovery in the markets," said Stepak.

The 15-percent trap

The day the transaction tax is replaced by capital gains tax at the banks, the capital market is liable to be buffeted by shock waves. This is because prior to the transition to the new tax regime, investors will have to choose between two tax tracks. There will apparently be a transition period at the banks from a transaction tax (1 percent on total deal value) to a capital gains tax (15 percent of the real gains from the deal) at the end of December 2003.

Investors who have various securities will be able to choose whether to sell them one day before the transition and pay a 1 percent fee, or to wait until the institution of the new regime. Anyone who has profited on his investments since the beginning of the year will favor the simple trick of selling his securities the day before the transition and repurchasing them the following day. Anyone who lost on his investments - even if he had previously considered selling a security - will be better off waiting until the capital gains tax is instituted in order to avoid paying an arbitrary transaction fee.

Let's say, for example, that an investor bought NIS 100,000 worth of participation units in a share-based mutual fund. Now let's suppose that on the day before the institution of capital gains tax those participation units are worth NIS 150,000. The investor knows that the bank at which he manages his account is about to switch to the new tax regime.

If the investor is interested in holding onto that investment, he now has two choices - to sell the participation units and buy them again the following day, or to do nothing. If he cashes in his investment while the transaction tax is in effect, he will pay NIS 1,500 (1 percent of NIS 150,000). If, however, he doesn't sell his participation units until after the transaction tax is canceled, his investment portfolio will have a tax debt of 15 percent - NIS 7,500 (15 percent of his NIS 50,000 gains). It is clear that the investor will prefer to pay 1 percent.

The banks will start charging a 1-percent transaction fee as of June 1, following the income tax commissioner's rejection of their request to continue charging 0.5 percent. This means that in the near future many investors will probably sell shares on which they have made a profit in order to pay only 0.5 percent on the transaction and then repurchase the shares at a new base value for capital gains tax purposes. If a share they own loses value in the coming months, the high value will serve as a good base for preventing the payment of capital gains tax in the future.

Income Tax Commissioner Tali Yaron-Eldar said Tuesday that if the commission sees that the banks will have difficulty collecting capital gains tax, the commission will suggest a solution. "So far no one has approached us in this regard," she said. Any solution will not be an easy one. "We'll have to think very hard, because every solution will cause other problems. It will require changes to the law," she explained.

Stepak suggested changing the law such that the base value for the transition to capital gains tax will be the value of investments on December 31, 2003, and that investors will pay a 1-percent tax on the value of their investments on that date, as if they had sold the investments and paid a transaction fee. Yaron-Eldar says that this type of solution would not be good for investors who lost money in 2003 and are interested in offsetting future profits.

Will the banks profit?

On December 31, 2002, instead of celebrating New Year's Eve, brokers at some investment houses were working all night at their offices, trying to achieve something that now seems ridiculous. They wanted to be ready before the banks started charging capital gains tax, on the assumption that in a bear market, private investors would prefer their accounts be handled by brokers who charge a real capital gains tax and who can offset losses.

Today, after the sharp rises in share prices, it is clear that those who switched to charging capital gains tax did not do their clients any favors. An investor whose portfolio is managed by a private broker will fare worse than an investor whose portfolio is managed by a big bank.

For example, a client who purchased shares for NIS 10,000 in early 2003 and has earned profits of NIS 7,000 will have to pay a bank NIS 85 (0.5 percent on the NIS 17,000 transaction) if he sells his shares before June 1, or NIS 170 (1 percent) between June and December 31, but will have to pay his broker NIS 350.

Some banks are ready to charge the transaction tax, but at this point it is clear that it is not worth collecting it, even when it goes up to 1 percent at the end of June. At this point there is a kind of balance of terror among the banks. No bank will switch to collecting capital gains tax, to the detriment of their clients, before the other banks - so they are all waiting. By law, December 31 is the last date for the transition to capital gains tax.

The banks are actually interested in switching to charging capital gains tax, because they are not thinking about the short term. They say the main reason they have not switched to charging capital gains tax is that it has not yet been determined how investment portfolios will be transferred from one bank to another, and how share price histories will be recorded.

Treasury not getting rich

The income tax commission's figures (published in TASE's April journal) show that over NIS 8.5 million was collected from the stock exchange each month in the first quarter of 2003, while over NIS 25 million were collected each month from taxes on savings plans in the banks. These figures, however, are not a good indicator of the future tax revenues, mainly because the taxes from the bourse are still from transactions and not from capital gains tax. If the stock market continues to prosper, the government's tax revenues will increase accordingly.