Israel’s tax treaty network is comprised of more than fifty double taxation conventions. In view of the fact that the provisions of these treaties are afforded the status of preferential law vis-à-vis the provisions of domestic Israeli income tax laws, the significance of these treaties cannot be overemphasized for non-residents of Israel deriving Israeli sourced incomes from business activities and investments. In addition to enhancing the measure of certainty as to the taxation implications on incomes derived in Israel by residents of the second Contracting State through dispositive rules, it is important to note that as a result of the status of the treaties provisions under international law, the interpretation of their provisions must be applied by tax authorities and courts in both Israel and the second treaty State in accordance with OECD norms and the principles of customary international law.
It is worthy of note that not only do the provisions of these treaties clarify the scope of Israel’s right to impose tax on Israeli sourced incomes derived by residents of States which are signatories to Double Taxation Conventions with Israel, moreover, in numerous instances the provisions of these treaties act to reduce the rates of tax imposed by Israel and even act to exempt incomes from Israeli tax altogether. This is often the result regarding incomes derived from activities carried out in Israel.
It is important for those involved in international commerce with Israel to recognize that numerous provisions adopted within Israel’s Double Taxation Conventions have recently undergone very significant revisions as a consequence of Israel’s membership in the OECD and signature on the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting. As such, the tax implications of those revisions need be carefully analyzed in tax planning and in responses to assessments taken out by the tax authorities.
Israel’s system of taxation sets forth a worldwide scope of taxation imposed on Israeli residents and a territorial scope of taxation as regards non-residents, whereby the incomes of non-residents are only subject to tax in Israel when their geographic source is in Israel. As such, clearly the determination as to one’s residence for tax purposes under Israeli taxation law defines the scope of his/her liability to tax in Israel.
Every year thousands of Israelis relocate abroad for periods exceeding one year. In light of Israel’s worldwide scope of taxation which is applied to those who are ‘residents of Israel’ under the Israel Income Tax Ordinance, the determination as to the liability to Israeli tax on their extra-territorial income will be a function of their residence status under Israeli tax law. Moreover, as a consequence of Israel’s tax treaty network and the provisions of Israel’s Double Taxation Conventions, even in instances where the relocating Israeli retains his status as ‘resident of Israel’ for domestic taxation purposes, his/her extra-territorial incomes may fall outside the scope of Israeli taxation by virtue of the Double Tax Convention.
It should be borne in mind that in addition to the implications regarding the imposition of Israeli tax on incomes sourced abroad, residence status under Israeli tax law (and residence status for purposes of Israel’s Double Taxation Conventions) is determinative as to the scope on liability vis-à-vis tax reporting requirements. Residency status is also relevant regarding the application of ‘exit tax’ under the Israel Income Tax Ordinance and the applications of numerous tax reliefs afforded as well under Israel’s tax treaties.
Taxation of new immigrants and returning Israelis
Included in Israel’s economic reliefs designed to assist new immigrants and returning Israelis in their entry into Israeli economic life, are far reaching tax reliefs granted to both categories. These tax reliefs grant, inter alia, a full exemption from Israeli tax for periods of up to ten years on non-Israeli sourced incomes and non-Israeli sourced capital gains. These provisions include as well, measures which can assist the new immigrants and returning Israelis in continuing to derive their foreign-sourced incomes through legal entities during the ten-year period. In order to fully derive the potential benefits, those entitled to them should evaluate the applicability of the provisions to their particular circumstances, even prior to their arrival in Israel as residents.
Israeli Controlled Foreign Service Companies
Israeli tax legislation contains specific provisions pertaining to incomes derived by Israeli residents via non-resident foreign services companies. This legislation is similar in concept to Israel’s ‘controlled foreign corporation’ type legislation in that it imposes Israeli tax on ‘deemed dividends’ in the absence of distribution, albeit the scope and application of these provisions concerned with services are clearly distinguishable from Israel’s provisions regarding foreign passive income derived by Israelis through non-resident passive investment vehicles. In view of the complexity of these provisions applicable to foreign service income, Israelis providing services through non-resident entities are well advised to carefully evaluate the taxation implications of such structuring prior to commencement of activities.
Israel's Foreign Passive Income provisions
In seeking to contend with concerns which have given rise to ‘controlled foreign corporation’ type legislation in numerous States throughout the world, in 2003 Israel adopted its version of such ‘look-through’ legislation. These provisions in the Israel Income Tax Ordinance are designed to preclude tax planning whereby Israelis could derive passive foreign income via non-Israeli resident investment companies and postpone Israeli taxation until such income is distributed as a dividend.
Notwithstanding the obvious justification for such legislation, the breadth of these provisions in Israel’s tax law are of such a nature that they can, in various circumstances, expose Israeli resident investors to taxation consequences which can, if not carefully evaluated in advance, give rise to consequences which lead to situations in which given investments are not commercially viable. In light of the complexity of these provisions and the scope of their potential tax implications, investors must give careful consideration to the investment vehicles utilized from the standpoint not only of commercial concerns, but the ultimate tax liability as well.
Issues of 'Permanent Establishment'
The measure of physical presence maintained in a State of source by a non-resident commercial entity finds expression in Double Taxation Conventions via the threshold test of ‘Permanent Establishment’ (PE). The determination as to whether the non-resident entity operates in the State of source through a PE is applied in determining whether a State of source is entitled to impose tax on the business incomes or incomes derived from the provision of services within that State of source by a resident of a second Contracting State, or alternatively, is required by the treaty to exempt such income from tax. The PE threshold is determinative as well as to the rate of income tax applied by a State of source on additional categories of income derived within its territory by a non-resident; inter alia, incomes from royalties, interest and dividends. Clearly, in sundry instances the determination as to the application of this threshold test can serve to be of critical importance to non-residents deriving incomes sourced in Israel as well as to residents of Israel deriving incomes sourced abroad.
Israeli incomes derived via US LLCs
The US LLC is a legal entity which is frequently used by Israeli residents for purposes of conducting their investments into the US. Albeit this vehicle has sundry advantages under US tax law, as it is granted the option of being taxed as a partnership rather than as a company, its use by Israeli tax residents has given rise to a number of potential obstacles which must be taken into account prior to its being selected for use by the Israeli investor.
One such potential obstacle which must be taken into account by the Israeli investor arises as a consequence of the fact that under Israeli tax law the LLC does not constitute a ‘look through’ entity, but rather is viewed as a separate legal entity from its unit holders. As such problems have frequently arisen vis-à-vis the receipt of tax credits in Israel for US taxes paid. Although the Israel Tax Authorities have made possible measures which can be undertaken by the investors for treating these issues, the investor must carefully consider whether the timing requirements existing under the proffered tax arrangements in Israel do not clash with his commercial interests in the US.
Additionally, the Israeli investor must carefully consider as well the implications which arise as a consequence of the fact that the LLC does not fall within the definition of ‘resident of the United States’ for purposes of the Israel-US Double Taxation Convention and therefore, such entity will not be entitled to the benefits provided for under that treaty.
In light of the potentially negative taxation implications existing for the Israeli investor’s utilization of the LLC as a vehicle for US investment, he/she must carefully examine the options available prior to entering into transactions via an LLC. Nevertheless, the advantages posed by LLCs should not be lightly discarded before deciding upon which type of US investment vehicle through which to make their investments.
Israel’s Capital Investment Encouragement Law
Israel’s Law for the Encouragement of Capital Investment grants exceptional tax incentives for investment in numerous spheres of Israeli commercial enterprises, inter alia, advanced research industries in the fields of bio, cyber and medical technologies. Tax rates can be as low as 6 per cent, and this, alongside additional incentives, including accelerated rates of depreciation. For foreign residents wishing to invest in Israel’s outstanding technological development industry, the extremely low rates of corporate tax legislated under this law, in conjunction with Israel’s large network of Double Taxation Conventions, can provide investment structures which ensure maximization of return on investment.
Clearly, the optimization of such potential requires careful scrutiny in advance of investment as to the resultant tax consequences, including the use of contemplated investment structures. Those structures should be planned together with an evaluation in advance as to the impact of the Israel Tax Authorities interpretation and application of its Double Taxation Conventions, taking into account Israel’s amended tax treaties in accordance with the OECD rules under the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting.
V.A.T. in international transactions
In transactions with Israeli residents where services are rendered to non-residents, frequently there arise issues as to the tax treatment of V.A.T., specifically whether a zero V.A.T rate is applicable. Clearly the implications of the determination to such question can have significant implications as V.A.T. is imposed at a rate of 17 percent. The questions which arise is this context are often multi-faceted and require careful analysis in advance as the result can be determinative as to the worthwhileness of a given transaction.
Taxation of intellectual property transactions
Numerous issues arise regarding the taxation of incomes derived from transactions involving the disposition of IP. This is the case in instances pertaining to the taxation both at the level of the institutions developing the IP as well as at the level of individuals deriving personal incomes arising from the IP. The implications of such issues frequently involve significant disparities between the initial positions adopted by tax authorities as to the rate of tax to be imposed and that rate of tax which should be applied to the incomes subsequent to the examination of all relevant facts and legal precedents.