ILDC Earned a 70% Return on Maariv Building in Three Years

The bargain sale price agreed upon three years ago was lower than fair market value but was conditional on rapid implementation.

When Ofer Nimrodi's Israel Land Development Corporation bought the landmark Maariv building in Tel Aviv from its subsidiary company Maariv Holdings for NIS 32.5 million in 2009, it was no routine transaction between business partners.

The bargain price agreed upon was lower than fair market value but was conditional on rapid implementation. The justification given for approving the sale was that it served the best interests of the company: The newspaper publishing group desperately needed the cash.

The agreed-upon amount was based on an assessor's report which estimated the fair market value of the property at NIS 36.8 million. Fair value usually represents a voluntary agreement between seller and buyer, both acting without external pressure. Disregarding the issue of the deal's propriety, the price reflected a 12% discount on its fair market value, which was offered in exchange for rapid implementation.

In its financial statements, Maariv Holdings did not describe this transaction as granting benefits to controlling shareholders, since even a third party would have received a reduced offer. It was therefore recorded as earning net capital gains of only NIS 5 million.

Another option which would have been acceptable under Israeli accounting standards would have been to base the valuation on the fair market value, reporting higher capital gains while recording the lower value as a preferential dividend based on the rapid implementation.

Until it lost control of Maariv Holdings, the financial reports published by ILDC did not reflect the implications of this transaction.

When a group purchases property from a subsidiary but then leases it back to the subsidiary, the transaction does not get reported. In other words, the property continues to be part of the group's fixed assets, valued at the reduced price at the time of sale, as though the transaction never took place. The profit made by Maariv Holdings in this case was canceled out in ILDC's financial statements, with no reflection of the fact that a sale was made at lower than fair market value.

The sale of Maariv Holdings to Zaki Rakib in 2010 led to a change in accounting procedures. It was now considered to be an affiliate of the larger group, with accounting based on its balance sheet value.

According to International Financial Reporting Standards, or IFRS, when a holding company leases property to an affiliate, this property is deemed to be real estate for investment purposes and is valued at fair market prices. The rationale for this is that an affiliate is considered an external entity.

In contrast, a subsidiary is part of the larger group, so that property it rents is still considered part of the fixed assets of the group.

Accordingly, when it relinquished control, ILDC was expected to determine the fair market value of the Maariv building. This implied the recognition of capital gains which were eliminated in its reporting, including the gains made due to rapid implementation.

Non-taxed accounting valuation

The estimated value of the Maariv building, reflected in the financial reports published by ILDC over the years, increased twice. The first time was to NIS 40 million, just before the company lost control of Maariv, and the second time was to NIS 53 million in early 2011.

If we assume that half of the second increase was due to additional investments, the increase still reflects a 45% increase over the purchase price. By adding an annual rental income of NIS 3 million, it turns out that Maariv Holdings yielded an impressive 70% return in three years for its owners.

The rapid implementation clause, amounting to a 12% discount, accounts for only a small portion of this return. ILDC reported that the Maariv building is in the process of undergoing a zoning change, with a plan to convert it into an office tower with increased building rights.

This should have been expressed as part of the valuation before the sale took place. The reports do not reflect any changes in estimated value after the sale took place, making it difficult to understand the gap in reported values.

This gap resulted from the change in accounting procedures, and reflects two concerns: One relates to a purchase by a controlling shareholder at a price that is lower than fair market value. The second concern relates to changes that took place after the transaction.

These changes give ILDC, as a public company, an incentive to increase the accounting valuation, since this is a gain that is not taxed.

The writer is an IFRS consultant and deputy dean (accounting ) of the Arison School of Business, Interdisciplinary Center (IDC ), Herzliya.