Corporate Tax 2020

Last Updated January 15, 2020

Israel

Law and Practice

Authors



Herzog Fox & Neeman is one of Israel's premier law firms, with a reputation as a market leader, through its involvement in major developments that shaped the Israeli economy. Its teams have experience in cross-border and domestic matters, which enables it to address clients’ legal needs across all industries. Herzog Fox & Neeman has one of the largest and most broadly experienced and diversified tax departments in Israel. The department is comprised of approximately 45 fee earners (including 16 partners) and provides an exceptionally wide range of services; ranging from corporate tax, indirect tax and transfer pricing to tax litigation and disputes with the Israel Tax Authority, private clients, investment funds and more. The Tax Department has a hugely diversified client-base, comprised of multinational companies that operate in Israel (such as Facebook, Google, Microsoft, and Salesforce), investment funds, ultra-high-net-worth individuals, Israeli companies (such as the Israel Electric Corporation and Mellanox Technologies Ltd) as well as non-profit organisations.

Most businesses conducting business activities and trade in Israel are incorporated as companies limited by shares, which may be public or private, or as partnerships (for partnerships, please see below). Public company shares are listed on a stock exchange or offered to the public pursuant to a prospectus. A private company is any company other than a public company.

Israeli companies are generally respected as separate entities from their owners. The Israeli corporate tax regime is based on two-tier taxation: first, at the company level and second, upon distribution of dividends to the company’s shareholders, at the shareholder level. Dividend income is subject to a lower tax rate than ordinary income (please see below).

Transparent entities commonly used include partnerships, which are treated as pass-through entities for Israeli tax purposes and, thus, are not subject to two-tier taxation. Only the partners in the partnership are subject to tax with respect to its income based on the pro-rata rights of the partners to the partnership income. Partnerships are widely used in the case of private equity firms and venture capital and hedge funds.

In a general partnership, each partner is liable for all the partnership's liabilities, as opposed to a limited partnership, in which the limited partners are liable only to the extent of their contribution to the partnership. Limited partnerships must have a general partner, who has unlimited liability. Only the general partner is allowed to participate in the management of the limited partnership.

Additional entities, which are not subject to two-tier taxation and are treated as transparent for Israeli tax purposes, include house property companies, which are minority companies (controlled by five or fewer persons, which meet several other conditions) whose assets and business are holding buildings. Certain family companies may appoint a "representative assessee" (a tax matters partner), who holds the rights to the highest percentage of the company's profits. The taxable income of the company is attributed to the representative and will not be subject to two-tier taxation.

A company is considered resident of Israel for tax purposes if it is either incorporated in Israel or incorporated abroad, but it is managed and controlled from Israel. According to guidance published by the Israel Tax Authority (ITA), a company is managed and controlled in the place where the business strategy of the company is determined, that is, where the business decisions of the company are made. The location of the board of directors meetings is an important, though not determinative, factor, especially where the board authorises another organ of the company to manage the company. In a 2012 Supreme Court decision, the directors of a foreign company acted as an artificial platform for conducting the business of the Israeli company and were not substantially involved in the business management of the foreign company. The Court ruled that the foreign company was to be regarded as having been managed and controlled from Israel.

Transparent entities are not considered residents of Israel for double tax treaty purposes and are usually eligible to claim treaty benefits based on the residency of the interest holder (that is, the ultimate beneficial owner of the income).

The corporate tax rate for incorporated businesses in 2019 is 23%. Permanent establishments of corporations are also subject to the regular corporate tax rate.

Capital gains and losses arising from real estate transactions located in Israel (including real estate associations) are taxed in accordance with the Land Taxation Law 5723-1963, at the applicable corporate income tax rate.

Transparent entities, such as business partnerships, are generally not subject to Israeli taxation at the level of the transparent entity but rather, are taxed based on the pro-rata rights of the partners to the partnership income. Thus, individuals may be taxed up to a 50% marginal tax rate (which includes a 3% surtax that is applicable to individuals with annual income over a certain threshold), and companies in accordance with the said corporate tax rate.

Israeli companies' income is taxed on a worldwide basis, while foreign companies are only subject to Israeli tax with respect to their Israel-sourced income.

The company’s net income, calculated using Israeli accounting principles and reconciled with the provisions of the Israel Tax Ordinance (the "Ordinance") and regulations, determines the tax base for corporate income tax purposes. In general, the accrual method of accounting is used by Israeli companies to report their income for accounting and tax purposes.

Tax and accounting rules differ in several areas, including accounting income derived from grouping rules that is eliminated for tax purposes, depreciation and amortisation rates and specific categories of expenses that may not be fully deductible, such as overseas travel expenses, vehicle expenses and similar expenses determined by relevant regulations.

In order to encourage start-up investments, Israeli tax law allows the deduction of up to ILS5 million invested in the shares of a company, immediately, or over a three-year period, by an individual or a partnership, provided certain conditions are met. This law is applicable until the end of 2019.

Companies deemed "preferred enterprises" are entitled to reduced corporate tax rates with regard to their "preferred income" generated by a "preferred enterprise" within Israel. Depending upon their locations, the tax rates for preferred enterprises are 7.5% or 16%, as of 2019 (depending on the region of the investment). Dividends distributed from certain preferred income are subject to 20% tax, in accordance with the Law of Encouragement of Capital Investments of 1959 (the "Encouragement Law").

More significant corporate tax reductions apply to large manufacturing companies, as profits of such companies are subject to 5% or 8% corporate income tax (depending upon the location of their manufacturing facilities).

In addition, "technology enterprises" that meet certain conditions are entitled to preferable corporate income tax rates on their preferred income, ranging from 6% to 12%. Subject to meeting certain conditions, including meeting a minimum 90% holding threshold, dividend distributions to foreign resident companies are subject to a 4% tax rate.

Assets and buildings used to produce certain preferred income are entitled to accelerated depreciation. During the first five years of operation, the company may depreciate its assets at 200% of the regular rate of depreciation with regard to equipment and 400% of the regular rate for buildings, with an annual upper limit of 20% of the value of the buildings.

Large manufacturing companies may also be eligible for grants of up to 20%, if certain conditions are met.

Losses incurred from a trade or business may be used to offset any other income or gain recognised by the company in the same tax year including interest, dividends and capital gains. Capital losses may only be offset against capital gains. Specific limitations apply to foreign-source losses. Net operating losses of a company may be carried forward indefinitely, although they may not be carried back. The balance of any unutilised losses in the same tax year may be carried forward indefinitely to be offset against business income and against capital gains from a business, but cannot be offset against income from any other source.

Carry-forward losses generally survive ownership change, although Israeli courts have ruled that, in certain circumstances, when a transaction is carried out for the sole purpose of utilising the carry-forward losses, such losses will not be recognised against the income of the company following the change of control. This is based on the anti-avoidance provision of Section 86 of the Ordinance, elaborated upon below.

Generally, sums paid on interest or linkage differentials are deductible, provided that the capital was used for the production of the income. In certain cases, such as the receipt of income with special tax rates, or tax-exempt status, the expenses used to obtain such income must be deducted, either proportionately or according to other methods, against preferred income. Thus, in certain circumstances, holding companies may be required to deduct interest payments against exempted or special-rate income and therefore do not fully benefit from this deduction.

In general, Israeli law does not allow for consolidated tax grouping. However, Israeli-resident "industrial" companies (a company that receives 90% or more of its revenues from an industrial entity involved in a manufacturing activity) or a holding company of industrial companies, may consolidate tax returns and file a single, consolidated tax return in respect of itself and its subsidiaries (that are also industrial companies), subject to such industrial companies included in the consolidated group being part of a single manufacturing process or assembly line. In the event that an industrial holding company has subsidiaries engaged in different assembly lines, it may consolidate its return only with regard to the company or companies with a single assembly line, in which it has the largest capital investment.

Local companies are subject to capital gains tax, according to the corporate income tax rate (23% as of 2019) upon the sale of shares of other companies. However, in the event that the company whose shares were sold is a non-publicly-traded company, or is a public company in which the selling company is a substantive shareholder (holds at least 10% of the means of control of the company), and has accumulated profits available for distribution, the portion of the selling company's gain attributed to the years prior to 2006 is subject to 10% tax, while the gain attributed to 2006 onwards is tax-exempt.

Foreign companies are generally exempt from capital gains tax upon sale of shares in Israel. See below for elaboration.

Incorporated businesses are subject to regular capital gains tax upon taxable transactions. In certain transactions, value added tax (VAT) may be imposed, as detailed in 2.9 Incorporated Businesses and Notable Taxes. In addition, there is no stamp duty in Israel, and transfer tax only applies upon certain transactions that involve purchase of real estate.

Israel charges VAT on transactions in Israel and on the importation of goods into Israel, at the standard rate of which is currently 17%. A transaction that is a sale of goods is deemed to have taken place in Israel if, in the case of a tangible asset, it was delivered in Israel or exported to Israel, and if, in the case of an intangible asset, the seller is an Israeli resident. Certain transactions are subject to a zero-rate tax (mainly exports of goods and services) or exempt (such as certain financial services and specific real estate transactions). Financial institutions are subject to profit tax and a tax on paid salaries (salary tax), both at a rate of 17%, subject to certain adjustments. Businesses are entitled to recover input VAT costs in connection with goods or services used by them to create their taxable (including a zero rate) supply.

Israel imposes customs duties on certain imported goods and sales tax on certain imported and domestic goods. Israel also imposes several duties, such as trade levies and dumping levies, in accordance with the Trade Levy Law.

It is difficult to ascertain how most closely-held businesses operate in practice. However, in the event that they do incorporate, the responses laid out below will apply.

The Israeli corporate tax regime is based on two-tier taxation:

  • tax at the company level - the corporate tax rate in 2019 is 23%, and;
  • tax at the shareholder level, upon dividend distribution - the dividend tax rate for shareholders is generally 25%, which rate is increased to 30% for shareholders who hold 10% or more of any of the company's means of control (substantive shareholders) at the time of the distribution or at any time during the 12-month period preceding the distribution. 

The highest applicable marginal tax rate on ordinary income is 47% (in 2019). Moreover, an additional 3% surtax will apply to any taxable income of an individual that is above ILS649,560.

Although dividend income is subject to a lower tax rate than ordinary income, when taken together with the corporate income tax rate, the total tax paid can be almost equal to the highest marginal tax rate applicable to ordinary income.

Nevertheless, domestic law subjects the income of closely-held companies, which stems from the personal exertion income of a substantive shareholder, to the marginal income tax rate, provided that several conditions are met. In addition, as elaborated upon below, in certain circumstances, a portion of the accumulated profits may be deemed notionally distributed.

As mentioned above, subject to meeting certain conditions, closely-held companies are taxed on the income that stems from the personal exertion income of a substantive shareholder at marginal income tax rates.

In addition, under certain circumstances, the ITA may deem accumulated profits of a closely-held company as distributed to its shareholders if the following conditions are met:

  • the closely-held company accumulates profits that exceed ILS5 million;
  • it has not distributed to its shareholders a dividend of at least 50% of its profits in a tax year, until the end of the five-year period following such tax year;
  • the distribution of the dividend does not damage or negatively impact the company; and
  • the lack of distribution results in tax avoidance or tax reduction.

The ITA may exercise such authority and deem up to 50% of such accumulated profits as distributed as a dividend (subtracting actual dividends paid), provided that the accumulated profits of the company do not fall below ILS3 million.

Generally, individuals are subject to 25% tax upon receipt of a dividend, increased to 30% if they are substantive shareholders (ie, hold 10% or more of any of the company’s means of control) at the time of the distribution or at any time during the 12-month period preceding the distribution. An additional 3% surtax applies on the income portion exceeding ILS649,560.

Generally, individuals are subject to 25% tax upon receipt of a dividend, increased to 30% if they are substantive shareholders (ie, hold 10% or more of any of the company’s means of control) at the time of the distribution or at any time during the 12-month period preceding the distribution. An additional 3% surtax applies on the income portion exceeding ILS649,560.

In the absence of an applicable income tax treaty, the following particular withholding taxes apply to payments to non-Israeli residents:

In general, payments made to non-Israeli individuals are subject to 25% withholding tax, and non-Israeli corporations are subject to withholding tax pursuant to the corporate income tax rate (23% in 2019).

Interest and royalties paid to non-resident corporations are generally subject to withholding tax at the corporate income tax rate level (23% in 2019) and up to 50% in the event of a payment to a person who holds 10% or more of the paying company's stock. Certain interest payments to non-resident investors are generally exempt from withholding tax, such as:

  • interest on certain traded government bonds;
  • interest paid by an Israeli resident on a loan from a non-Israeli resident; and
  • interest on deposits by a non-Israeli resident, provided the non-Israeli resident does not conduct business, or practice a profession in Israel.

Dividends distributed to non-substantive shareholders (who hold less than 10% of the means of control of the paying company) are subject to 25% withholding tax, while dividends to substantive shareholders (at the time of the distribution or at any time during the 12-month period preceding the distribution) are subject to 30% tax. However, if the Israel-resident company distributing the dividend is a publicly traded company, whose shares are held by a registration company, then 25% withholding tax will also apply to substantive shareholders. In the case of a dividend distribution by a preferred enterprise, a reduced rate of withholding tax of 20% applies; and in the case of a dividend distributed by a technology enterprise, a reduced rate of withholding tax of 4% may apply under certain circumstances.

As of 2019, there are over 50 double tax treaties to which Israel is party to and that are in force in Israel. Israel generally follows the Organisation for Economic Co-operation and Development (OECD) Model Convention, with the exception of a number of treaties (such as Norway and Sweden) signed in the 1960s and the 1970s, before the OECD model was widely accepted. Israel signed the Multilateral Instrument in June 2017.

An ITA circular describes the phenomenon of "Treaty Shopping" and lists several methods with which this issue may be confronted, such as:

  • examining the residency of the entity, based on the rules determined in the relevant treaty;
  • limitation of benefits provisions that allow the contracting states unilaterally or jointly to revoke or disallow benefits, in cases whereby the entity attempts to secure tax benefits unlawfully, or if the activity is deemed to be abuse of the treaty;
  • beneficial owner provisions, which determine that only the ultimate beneficiary may be the recipient of treaty benefits;
  • interpretation of the treaty based on the Vienna Convention, which calls, among other things, for treaties to be interpreted in good faith; and
  • use of domestic anti-avoidance legislation, such as Section 86 of the Ordinance.

Foreign corporations that conduct business activity in Israel must operate in accordance with accepted transfer pricing standards and, in particular, the arm’s length principal.

In an international transaction where due to special relationships between the parties, less profit is derived in Israel as compared to the price or conditions been between unrelated parties, the transaction must be reported according to the market conditions and will be taxed accordingly.

Regulations published in 2006 specify certain methods to determine fair market value. The preferred method is to compare the price of the transaction with the price of a similar international transaction between unrelated parties. If this method cannot be implemented, the taxpayer must use one of the methods stipulated in the regulations. If neither of the methods indicated in the regulations can be used, the taxpayer is permitted to use any other suitable method of comparison.

The local affiliate of a non-Israeli entity is not specifically required to prepare an annual transfer pricing study; however, the tax-assessing officer has the authority to demand a transfer pricing study within a 60-day period. Moreover, taxpayers are obligated to describe the terms of any international transaction with a related party in its annual tax return.

This is an issue that the ITA has been examining. Many audits have been carried out recently by the ITA with respect to limited-risk distribution arrangements.

In general, Israel's local transfer pricing rules follow the relevant OECD standards.

When a transfer pricing claim is settled, the ITA usually claims for a correlating adjustment. This adjustment may be in the form of a deemed dividend or interest on a loan. The Courts in Israel have approved this position in their decisions.

In a 2018 Supreme Court case, an Israeli company provided research and development (R&D) services to its parent company under a cost-plus arrangement. The Court ruled that given the price of the services the Israeli company provided to its parent company was higher than the amount reported to the ITA, this created an inter-company debt of parent company to the Israeli company equal the extra amount that should have been paid and reported. Due to this debt, the parent company should have been charged with interest and therefore, the Israeli company had a corresponding deemed interest income inclusion, which is subject to tax in Israel.

A branch of a non-Israeli entity is taxed in Israel on the profits the branch derives from its Israeli activities, while a local subsidiary is generally taxed on its worldwide income. The corporate income tax rate in Israel is 23% (in 2019) and thus, the taxable profits of the branch allocable to Israel are subject to such tax.

Generally, there is no branch profits tax in Israel and profits may be distributed by the branch to the overseas headquarters without an additional layer of tax.

In the case of dividends paid by an Israeli subsidiary to overseas shareholders, the withholding tax rate is generally 30%, or if the Israeli subsidiary is listed on the Tel Aviv Stock Exchange (TASE), the withholding tax rate is reduced to 25%. Such rates may be reduced further under an applicable double-tax treaty. The withholding rate in the case of a subsidiary can be alleviated if the profits are distributed only when the subsidiary is liquidated. In this case, the capital gains derived from the liquidation, as well as the distribution of the profits, will be tax-exempt in Israel. On the other hand, the sale of a branch by a non-local corporation is subject to capital gains tax in Israel.

Capital gains of non-Israeli residents on the sale of stock in public companies traded on the TASE are generally tax-exempt, provided that the capital gains do not stem from a permanent establishment of such non-Israeli resident in Israel, from investments in certain real estate funds or from the sale of certain short-term bonds or loans.

With regard to capital gains of non-Israeli residents on the sale of stock in private companies, the gains are tax exempt, provided that they did not arise from a permanent establishment of such non-Israeli resident in Israel, that the stock was not purchased from a related party or restricted due to certain tax-free reorganisations, and that the principal value of the stock does not derive from real property, any asset attached to real property, or the right to benefit from real property situated in Israel, in any form, or rights to use natural resources. It should be noted that a non-Israeli resident who acquired the shares of an Israeli company after 1 January 2009 will often be exempt from tax in Israel from capital gains on the sale of the shares.

The exemption on capital gains on the sale of stock of non-traded companies also applies upon the sale of the shares of a non-local holding company that owns the stock of a local company, either directly or indirectly.

Certain treaties provide partial or full relief with respect to corporate capital gains taxes on non-Israeli residents, subject to satisfying certain conditions.

In general, pursuant to the provisions of the Ordinance, a non-Israeli resident company is exempt from tax on capital gains generated from the sale of securities of an Israeli resident company or the sale of a right in a non-Israeli resident company, the main value of which are rights, either directly or indirectly, in assets located in Israel, including shares of an Israeli subsidiary (subject to certain additional conditions).

As mentioned above, the tax exemption generally applies if the acquisition was made by a non-Israeli resident after 1 January 2009, as opposed to an acquisition made before 1 January 2009, which is generally subject to capital gains tax in Israel (although certain other domestic law exemptions may still be applicable).

The taxable profits of a local branch of a non-Israeli company are generally calculated by reference to the income and deductions attributable to the branch under the assumption it operates as an independent business unit and in accordance with transfer pricing rules. The income tax regulations stipulate that if the transaction cannot be compared to a similar transaction, the value of the transaction should be determined based on the profit rate of the transaction, compared to similar international transactions, or carry out a profit split based on the contributions and risks of each party to the transaction. If none of the above-mentioned methods are applicable, then the most appropriate method must be applied on a case-by-case basis.

The Ordinance, however, does not include specific rules regarding the taxation of a branch or the allocation of income and expenses to a branch in Israel.

There is no specific standard applied. The deduction must be carried out in accordance with the fair market value of such services.

Israel does not impose thin capitalisation rules and, therefore, it is theoretically possible to finance a company with 100% debt. However, this type of debt arrangement is subject to transfer pricing rules and must bear interest in accordance with fair market interest rates.

In addition, it is possible to provide an interest-free capital note, provided the recipient of the loan is controlled by the provider of the loan, the loan is not linked to any index and does not carry interest or yield, the loan must not be repaid prior to a five-year period and its repayment must be subordinate to all other obligations of the company.

The foreign income of local companies is subject to corporate income tax, as in general, local companies are taxed on their worldwide income at the corporate income tax rate (23% in 2019), as opposed to non-Israeli companies, which are only subject to Israeli tax with respect to their Israel-sourced income.

As noted above, foreign income is subject to taxation at the regular corporate income tax rates.

Dividends from foreign subsidiaries of local companies are subject to regular corporate income tax rates (23% in 2019). However, tax credits are available in such cases.

The Israeli local company may claim foreign taxes paid with respect to the distribution as credit pursuant to one of the following methods:

  • direct credit, where the Israeli company may claim credits with respect to foreign withholding taxes paid on the dividend distribution, in which case, the dividend distribution will be subject to a 23% rate in Israel (as of 2019); and
  • indirect credit, where the Israeli company may claim credits with respect to its allocable share of the foreign taxes paid by the distributing company on its foreign source income and the foreign withholding taxes paid on the dividend distribution, in which case, the dividend distribution will be subject to the regular corporate income tax rate in Israel (also 23% as of 2019).

In general, in order for non-Israeli subsidiaries to use intangibles developed by local companies, the intangibles must be either sold to such subsidiaries, or, alternatively, the local company may license the intangibles to non-local subsidiaries, providing them with rights to use the intangibles in return for proper consideration. All the above is subject to compliance with transfer pricing rules.

Non-local subsidiaries may be subject to controlled foreign corporation (CFC) rules, provided that they meet several conditions.

A controlling shareholder of the CFC is an Israeli resident (individual or corporation) that owns 10% or more of any of the means of control of the CFC. The controlling shareholder’s proportionate amount of the CFC’s passive income is deemed a dividend distribution to the controlling shareholder.

A CFC is a foreign company that is a non-Israeli tax resident, not listed on an exchange, (or, if listed, less than 30% of the interests of which have been offered to the public), not including shares held by controlling shareholders. In addition, most of the company's income must stem from passive sources and such passive income is subject to a 15% or less tax rate in the foreign jurisdiction. Moreover, the foreign company must be controlled by Israeli residents (ie, Israeli residents hold over 50% of the interests in the foreign company, or over 40% of the interests in the foreign company and together with the holdings of related parties, hold over 50%, or if an Israeli resident has veto power over major company decisions).

On the other hand, non-local branches of local corporations are deemed to be Israeli tax residents and are therefore subject to corporate income tax on their worldwide income, whether from Israel or abroad. However, tax credits may be available in such cases.

As mentioned above, a company is deemed to be a resident of Israel if it was incorporated in Israel, or if it was incorporated abroad and is managed and controlled in Israel. Non-local subsidiaries of Israeli resident companies are subject to a management and control test, according to which, a company is managed and controlled in the place where the business strategy of the company is determined, ie, where the principal and substantive business decisions of the company are made. The location of the board of directors’ meetings is important, although not determinative, especially in a case where the board authorises a different organ of the company to manage the company. Israeli case law determines a foreign company to be managed and controlled from Israel, whereby the managers of the foreign company are not substantially involved in the foreign company’s business management and merely act as an artificial platform for conducting the business of the Israeli company.

Local companies are taxed on gain on the sale of shares in non-local affiliates according to the regular corporate income tax rate (23% in 2019).

The Ordinance includes a general anti-avoidance provision in Section 86, according to which, a tax-assessing officer may ignore transactions that are deemed to be artificial or fictitious, or if one of the main motivations of such a transaction is tax avoidance. In addition, the "substance over form" doctrine is a generally-accepted principle of local case law.

Generally, tax audits are carried out randomly and not all taxpayers and tax returns are examined.

In addition, within four years (and in certain circumstances five years) from the end of tax year in which a tax return was filed, the assessing officer may audit a company’s tax return. The assessment of the officer may be appealed to another officer within the same local office. The decision of the second officer is subject to appeal to the District Court. The decision of the district court may be appealed to the Supreme Court.

Israel has already begun to implement certain BEPS recommendations and we expect this process to continue gradually. So far, implementation has mostly occurred through changes in the interpretation of existing law and tax treaties, rather than through changes in legislation.

In 2016, following BEPS Action 1, which focuses on the digital economy, the ITA published a circular addressing the taxation of income applicable to non-Israeli Internet companies selling goods or providing services to the Israeli market through the Internet, as well as the VAT liability of Internet services companies. The circular extends to the VAT registration obligation of non-Israeli companies active in the Israeli market and, in addition, provides new, broader interpretations with regard to the definitions of a permanent establishment conducted through dependent agents and fixed places of business.

Following the BEPS Action 5, which addresses harmful tax practices and consistent with the OECD’s so-called “nexus approach” relating to preferential tax regimes for intellectual property, the Israeli government recently enacted legislation granting preferential tax rates to technology and hi-tech companies with respect to income derived from intellectual property development activities carried out in Israel. The new legislation determines a new IP regime in Israel by granting preferential tax rates to technology and hi-tech companies developing their intellectual property in Israel. In order to be entitled to these preferential rates, the new legislation sets out certain complex conditions to ensure that the benefits are only provided when the IP is actually developed in Israel. These tax benefits are part of a significant reform under the Encouragement Law, in light of the recommendations of the OECD BEPS Project.

Proposed legislation to implement BEPS Action 13 recommendation regarding transfer pricing documentation (including a "Country by Country" report and master and local filings) has already been published. The proposed legislation enacts a new reporting regime for taxpayers of a multinational entity that has engaged in an international transaction. In this regard, the taxpayer may be required to provide the ITA with the complete documentation regarding the international transaction, including documents regarding the method used for the price calculation, as well as forms and information regarding the multinational enterprise itself.

The ITA has indicated that it intends to follow and implement the OECD’s recommendations in the BEPS reports and accordingly, we expect to see amendments to domestic legislation, the enactment of regulations and the publication of guidance papers by the ITA, which will indicate the ITA’s position. In addition, discussions with Israel’s treaty partners are anticipated, and the OECD’s recommendations implemented. Israel is also a signatory to, and has ratified, the Multilateral Instrument (MLI).

International tax has significant media exposure and hence, a high public profile in Israel, especially with respect to the taxation of non-Israeli Internet companies, which has given rise to public protest. The protesters claim that these non-Israeli Internet companies, such as Google, do not pay sufficient tax on their activity in Israel. We expect that the media focus on this issue, together with the high public profile, will increase Israel’s motivation to implement the BEPS recommendations. 

Although the government is trying to encourage investments in the Israeli economy, we expect the competitive tax policy to be restricted as a result of the BEPS recommendations, which will surpass other considerations.

An example of this can be seen in the recently enacted amendments to the Encouragement Law, which provides for preferential tax rates to be granted to technology and hi-tech companies, but only with respect to income derived from intellectual property developed in Israel. This law was revised in accordance with the BEPS Action 5. In this regard, the Israeli regulations have adopted the principle proposed in the BEPS rules (the so-called "Nexus Approach") for calculating the qualifying income and the benefitted capital gain, in order for it not be considered a harmful tax regime.

As part of the Encouragement Law, Israel grants extensive tax benefits to Israeli manufacturers. In certain cases, this contradicts the BEPS Action 5 and the Nexus Approach, which limits the ability to grant benefits where the intellectual property has not been developed in Israel.

Israel has not yet implemented these changes and there is no draft legislation proposing implementation. However, as stated above, the Israeli government is committed to implementing the BEPS recommendations and, as such, we expect the legislation to be published in the near future.

Israel has a territorial tax regime (combined with a personal tax regime). However, there are no interest-deductibility restrictions or thin capitalisation rules. We are not aware of any intention on the part of the ITA to enact such rules.

Israel has a very sophisticated CFC regime, ratified almost 15 years ago. The main features of the Israeli regime are very similar to the BEPS recommendations regarding the CFC rules.  Accordingly, we do not expect any significant change to the Israeli CFC regime as a result of the BEPS legislation.

Israel maintains a conservative approach with respect to granting treaty benefits, and such benefits are granted subject to the existence of substance in the treaty country.

There is limitation on benefits clause only in a minority of the Israel treaties (though it exists in the Israel-US treaty). However, there is a court ruling determining that Israel is entitled to implement anti-avoidance doctrines from its domestic legislation when interpreting tax treaty provisions. For example, the establishment of a foreign company in a treaty country may be considered artificial, where the purpose is to avoid the payment of tax. 

As noted, Israel has ratified the MLI.

Israel complies with, and encompasses most of, the BEPS proposals with respect to the DTC limitation. Accordingly, we do not expect significant impact on inbound and outbound investors.

In 2018, the ITA published two circulars concerning transfer pricing.

The first circular provides guidance, which is based on the OECD transfer pricing guidelines, for identifying and analysing intercompany activity and the most appropriate transfer pricing method for determining the activity's part in the global business activity. In accordance with the BEPS recommendation, the circular suggests that the analysis should first begin by reviewing the contractual arrangements, followed by examining the parties' conduct in order to ascertain if it is consistent with the contractual arrangements.

The second circular, also based on the OECD transfer pricing guidelines, presents the ITA's position with respect to a number of transactions, while reducing the burden of the documentation and reporting requirements, by way of the safe harbour principle. The circular sets a safe harbour for the following transactions:

  • low value-adding services, having an operating profitability of net-cost plus margin of 5%;
  • marketing services, having operating profitability of net-cost plus margin between 10%-12%; and
  • low-risk distribution services, having an operating profitability of sales as turnover of between 3%-4%.

The circular mentions that the margins will be revised from time to time.

We believe that the BEPS proposal for transparency and country-by-country reporting will improve enforcement and that, overall, the proposal is proportionate, as it only applies to large entities and will not impose unreasonable compliance costs on small entities. As noted above, there is proposed legislation in Israel to implement this recommendation.

As noted above, the ITA has published a circular, which is focused on the taxation of income by non-Israeli Internet companies selling goods or providing services to the Israeli market through the Internet, as well as the VAT liability of Internet services companies. The circular generally provides new, broader interpretations to the definitions of a permanent establishment conducted through dependent agents and fixed places of business, and expands the VAT registration obligation of non-Israeli companies active in the Israeli market.

Israel has not yet enacted laws addressing digital economy taxation rights. As noted above, the ITA has published a circular which takes somewhat aggressive position. For treaty-partner countries, the circular expands the interpretation of a permanent establishment (PE) through a “fixed place of business” or a “dependent agent” in such tax treaties in the context of digital economy.

For a fixed place of business PE, the circular states that a PE may exist even where there is no Internet server located in Israel, and notes that certain activities of representatives and employees of an Israeli affiliate of a non-resident company in Israel such as identifying potential clients, marketing activities and client relationship management, when conducted with assistance from, or through, a place of business in Israel, may create a PE. In effect, the ITA’s position is equivalent to attributing the activities of an Israeli affiliate of a multinational group to a non-Israeli affiliate within the group.

With respect to creating a PE through a “dependent agent”, the circular adopts the “principal role” approach pursuant to which increased involvement of the agent in Israel in negotiations on behalf of, and decisions that bind, a non-Israeli company, reinforce the conclusion that the dependent agent will be treated as a PE of such company. Under this approach, if employees of an Israeli affiliate of a multinational group perform substantive activities that lead to binding contracts, a PE in Israel may be established (by essentially deeming such employees as dependent agents of a non-Israeli affiliate within the multinational group).

For companies' resident in non-treaty jurisdictions, the circular notes that the ITA will acquire taxing rights over a non-Israeli taxpayer based on domestic law principles (namely, business activity conducted in Israel, which generally requires a lower threshold than the PE treaty standard). One of the examples that the circular cites as meeting this standard is the existence of “significant digital presence” even without a physical presence in Israel. Indications of the existence of a digital presence in Israel include a significant number of contracts signed with Israeli residents via the Internet, a significant number of customers in Israel that consume the services provided by such company, and the services over the Internet have been adapted to suit Israeli customers such as a website in Hebrew, using local currency and local credit card clearance.

There is no specific legislation that addresses taxation of offshore intellectual property. Payments to non-Israeli corporate owners of intellectual property by Israeli residents for use or license rights of such intellectual property are generally subject to withholding at the corporate income tax rate (23% in 2019), unless otherwise reduced by a double tax treaty. 

This is not applicable in this jurisdiction.

Herzog Fox & Neeman

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4 Weizmann Street
Tel Aviv
6423904
Israel

+972 3 692 2020

+972 3 696 6464

www.hfn.co.il
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Law and Practice

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Herzog Fox & Neeman is one of Israel's premier law firms, with a reputation as a market leader, through its involvement in major developments that shaped the Israeli economy. Its teams have experience in cross-border and domestic matters, which enables it to address clients’ legal needs across all industries. Herzog Fox & Neeman has one of the largest and most broadly experienced and diversified tax departments in Israel. The department is comprised of approximately 45 fee earners (including 16 partners) and provides an exceptionally wide range of services; ranging from corporate tax, indirect tax and transfer pricing to tax litigation and disputes with the Israel Tax Authority, private clients, investment funds and more. The Tax Department has a hugely diversified client-base, comprised of multinational companies that operate in Israel (such as Facebook, Google, Microsoft, and Salesforce), investment funds, ultra-high-net-worth individuals, Israeli companies (such as the Israel Electric Corporation and Mellanox Technologies Ltd) as well as non-profit organisations.

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