Our clients receive personal service from an Israeli tax specialist who has extensive experience in related legal fields, including litigation. The services I provide include:
- Mergers & Acquisitions Tax services
- Transaction Support
- Tax Opinions
- Forms of Business Organization
- Real Estate Transaction Tax
- Tax Incentives
- Tax Litigation and Controversy
- International Tax
- VAT Consulting
- Taxation of Foreign Income
- Taxation of Virtual Currencies
- Taxation of Trust
- Taxation of Virtual Currencies
Below you will find a concise overview of the Israeli international taxation aspects for 2020 which I recommend reading together with the 2020 overview of the Israeli domestic taxation.
A. Residence and Territorial Based Tax
The Israeli Tax Ordinance (ITO) imposes income tax on a personal and territorial basis – Israeli residents (for tax purposes) are subject to tax on their worldwide income and foreigners if the income was produced in Israel.
B. Determination of Israeli Residency
Individuals
An individual residency for tax purposes is determined by the "Life Center״ test, as defined in the ITO and outlined by the Israeli court's rulings. The ITO establishes legal presumptions that an individual's center of life is in Israel if the individual stayed in Israel for 183 days or more in a particular tax year, or if the individual stayed in Israel for at least 30 days and together with the two previous tax years at least 425 days. However, the ITO also provides that it is a contradictory presumption and that in order to determine residency, the entire individual's affiliation to Israel must be examined (permanent place of residence, the family unit, place of occupation and economic interests, activity in organizations, social relations and more).
Corporate Residency
A company is an Israeli tax resident, if it is incorporated in Israel or if its business control and management is exercised in Israel (except in some cases, if the controlling shareholder is a new immigrant or a returning resident). The courts have determined that the control and management tests are cumulative, that is, it is required that the place of strategic policy and daily management be carried out from Israel in order for a company not registered in Israel to be considered a tax resident. It was also held, that the emphasis is less on physical placement in which the formal final decisions are made but on the decision-making process.
Anti-Avoidance Provisions
The ITO provides two main provisions, which aim to tax the profits of non-resident companies (for tax purposes) from abroad, in cases where the legislator considered that the structure was formed by Israeli residents in order to evade the Israeli tax base.
Foreign Controlled Company
According to the Israeli CFC regime, a foreign controlled company is, in general, a foreign resident, in which Israeli residents own, directly or indirectly, more than 50% of at least one of its means of control and most of its income in a given tax year is from passive sources that are taxed at a foreign rate of no more than 15% (and if it is a public company then less than 30% it's shares are traded on the stock exchange).
The Israeli resident shareholder in the CFC will be taxed for his share of the company's income each year as if he received an actual dividend (and will be credited later (upon actual distribution) for the foreign tax).
Foreign Occupation Company
The provision regarding the taxation of a Foreign Occupation Company is designed to prevent the diversion of income of freelancers with "special occupation" (as defined in the ITO) to a foreign company while taking advantage of the two-tier taxation model.
A Foreign Occupation Company is defined as a minor (held by few) non-resident company in which 75% of its means of control are held by Israeli residents and that most of its income or profits derive from "special occupation".
Provided that its controlling shareholders (at least 50%) are engaged in such occupation, the substantial shareholders (10%) will be taxed on their share of the income for that tax year (at the Israeli corporate tax rate, after foreign tax credit), as well as on dividends upon distribution (other shareholders will be taxed on both stages upon distribution).
C. Nonresidents Taxation in Israel
Place of Income
Section 4A of the ITO states, with respect to each source of income, where the place of income is:
In respect of business income – the place where the income yielding business activity takes place; in respect of income from business or from incidental business of a commercial character – the place where the transaction or the business takes place; in respect of income from an occupation – where the service is performed; in respect of work income – where the work is performed but if the employer is an Israeli tax resident and the employment relationship began when the employee was also - in Israel; in respect of interest, discount and linkage differentials and gain or profit, including royalties, that stem from an intangible asset – the payer's place of residence and if from the foreign resident's permanent enterprise in Israel – Israel ; in respect of rent or fees for the use of an asset – where the asset is used; in respect of gains or profit from gambling, lotteries or prize winning activity – the place of residence of the person who pays the said gains or profits; in respect of a pension, usufruct or annuity – the payer's place of residence but if the employer is an Israeli tax resident and the employment relationship began when the employee was also - in Israel; in respect of income from agriculture – the place of the asset that yields the income; in respect of dividends – the seat of the body of persons that pays the dividend.
Branch/PE
Branch profits (of a foreign company) are calculated in accordance with transfer pricing rules in Israel as an independent economic unit and taxed at an Israeli corporate tax rate (unless a tax treaty provides otherwise). There is no additional tax on distribution of branch profits.
Withholding Tax
There is a fairly extensive withholding tax obligation (for payers with a certain revenue cycle) and it also applies to payments to nonresidents and from "in-kind" payments such as stock allocation, conversion exchange, etc. The obligation also applies to a PE in Israel and to the responsible for the payment (such as a trustee). The rate is fixed by law according to the nature of the payment (for payments to companies it is the corporate tax rate - currently 23%) and subject to the absence of another provision in a tax treaty or prior approval from the ITA.
Exemptions to Nonresidents
The Income Tax Ordinance stipulates some exemptions for nonresidents. The main exemption is the capital gain exemption from the sale of shares of private Israeli companies (subject to certain conditions). This exemption does not apply if on the date of purchase of the shares and in the two years prior to the sale the value of such privet company originates mostly from real-estate in Israel or from the right to exploit natural resources in Israel.
There are other exemptions (subject to conditions) such as from the sale of traded securities and interest on a government bond on the Tel Aviv Stock Exchange. In addition, there are tax discounts on dividends to non-residents originating from an "approved enterprise" under the Capital Investment Encouragement Law.
It is important to note that not every foreign resident is entitled to the above exemptions, because section 68A of the ITO excludes any tax benefit, discount or exemption given to a foreign company if Israeli residents own 25% or more of its rights, directly or indirectly.
D. Tax Treaties
Israel is a signatory to dozens of tax treaties and according to section 196 of the ITO they override the other provisions of the ITO. Israel has signed the Multilateral Convention to Implement Tax Treaty Related measures to prevent Base Erosion and Profit Shifting (“MLI”), adopted the principal purpose test (PPT) as anti-avoidance rule, and reserved from the arbitration clause (in the event of an unresolved dispute between the tax authorities).
E. Foreign Tax Credit
The ITO allows Israelis a credit for a foreign tax paid to the extent that it is paid on a territorial basis and not due to residency in the foreign country. The credit is granted according to the "baskets" method, that is a foreign tax paid for one of the income sources in the ITO will generally only be offset against the Israeli tax liability for income from the same source. If the foreign tax exceeds the tax liability, the balance will be credited in future years. It should be noted that not every foreign tax is creditable (but only as defined in the ITO).
Companies that receive a dividend from a foreign subsidiary can choose between two credit mechanisms set out in the ITO: the first is the direct credit mechanism, whereby a credit will be given for the tax originally withheld from the dividend )against the Israeli tax liability on the dividend( and the second - the indirect - whereby the foreign tax paid will be added to the dividend, the above total amount will be taxed in Israel, and a credit will be given for both the tax withheld from the dividend and the foreign tax paid by the subsidiary on its overseas operations (the source of the dividend).
This mechanism can be operated up to two "layers" (apply also to granddaughter company and it should be noted that partnership is not a separate entity for tax purpose).
F. Exemptions for Immigrants and Returning Residents
New immigrants as well as returning residents who returned to Israel after 10 years of foreign residency (for tax purposes) are given the option of a first "year of adjustment" during which they will be still considered foreign residents (if eventually they decide not to stay). If, however, they decide to stay in Israel, they will be exempt from their total income from abroad for 10 years from their immigration/return. In addition, their change of residency per se will not classify a company controlled and managed by them as an Israeli resident, nor will the provisions of the CFC and the FOC mentioned above apply. Other returning residents (who returned after two years) are also entitled to exemptions, but only on passive income from abroad and for five years period.
G. Detachment of Residency and Exit Tax
According to the ordinance, a "foreign resident" is a person who is non- Israeli resident or who has been abroad for at least 183 days during both the tax year and the tax year thereafter, and whose center of life was not in Israel during the two subsequent tax years. This means that change of residency is possible from the date of departure even if during the first two years the center of life is still in Israel. A foreign company is no longer tax resident from the date it is controlled and managed from abroad.
The date of change of residency is of great importance because "Exit Tax" is imposed - a capital gain for the notional sale of the assessable assets of a taxpayer who has ceased to be a resident. The tax can be paid at the "departure" (at par) or at the actual realization date (and then the capital gain will be calculated linearly).
H. Trusts Taxation
Trust income derived outside of Israel is also taxable in Israel unless all the creators and beneficiaries are foreign residents or alternatively all the beneficiaries are such and it is also an irrevocable or will trust (and then the income will be regarded as income of the beneficiaries). Alternatively, and only if it is a relative's trust (created by non-resident relatives) it is possible to choose between a tax rate of 30% of distributions or 25% of annual income. There are also some exemptions to a trust which the creators and beneficiaries of are new immigrants or returning residents or created by those who were before 1.8.2013.
I. VAT - International Tax Aspects
The Tax Base
VAT is mainly imposed on services or on the sale or rental of assets in Israel, as well as on imports to Israel.
An asset will be considered as sold in Israel if it was in Israel at the time of delivery to the buyer, or if it is exported from Israel, and if an intangible - if the seller is an Israeli resident. A service transaction is in Israel if the service provider is someone who has business in Israel or who has an agent or branch in Israel, or when the service is provided to an Israeli resident, or it is given in connection with assets located in Israel.
Financial institutions and non-profit institutions are exempt from VAT, but there is an alternative tax on the added value of the entity (payroll tax and / or profit tax) if the activity is managed in Israel. Activity is managed in Israel to the extent that the activity is conducted wholly or mostly in Israel, or run by someone whose main business is in Israel (and the activity is in the field of such business), or if it is the part that is managed in Israel from an overall activity that is managed mostly outside of Israel.
Zero rate VAT on International Transactions
Zero rate VAT applies, inter alia (and under certain conditions), to the export of goods and intangibles (protected rights), and to service to Israeli residents abroad or foreign residents (except if the subject of the agreement is the provision of service also to Israeli residents or to another foreign resident in Israel, or regarding an asset in Israel). However, a condition for providing the above benefits is that the "foreign resident" who receives the service has no "activity or business in Israel" (and this requires special consultation, especially in the case of a group of companies).
J. Transfer Pricing
The ITO provides that an international transaction between related parties shall be calculated (for tax purposes) under market conditions and it is also mandatory to report to the ITA on such transactions. If required, the adjustment will be made according to the Comparable Uncontrolled Price Method or, if not possible, according to the Comparable Profits Method or the Profit Split Method. Transfer pricing study is not mandatory, but the ITA has the authority to require it within 60 days. The ITA has issued a number of circulars on the subject in accordance with the OECD guidelines, including some possible Safe Harbors.
You are welcome to contact us for further details and professional service on any of the above issues.
