It was only recently that we published an article reviewing the recently enacted tax provisions concerning corporate taxation and capital investments encouragements, which were enacted as part of approving the economic policy program and the government budget for the years 2017 and 2018. Surprisingly, this week, the Israeli government published a new bill ("the Bill"), proposing additional amendments of the Israeli Tax Ordinance (New Version), 1961 ("the ITO"). The Bill proposes revolutionary provisions concerning management and control of companies registered outside Israel ("Management & Control") amendments to the provisions concerning Controlled Foreign Company ("CFC"), and new liabilities concerning Transfer Pricing ("TP").
Management & Control
The current wording of section 1 of the ITO provides that a body of persons would be deemed an Israeli resident if it was either incorporated in Israel or if its business is managed and controlled in Israel. The legislator has not set clear rules or conditions for examining the place of Management & Control of a body of persons and, therefore, this issue has caused numerous disputes between the Israeli Tax Authority ("ITA") and taxpayers holding shares in foreign companies.
The Bill proposes amending the provisions of section 1 of the ITO by adding a list of conditions under which the Management & Control of a foreign company would be presumed in Israel, unless the presumption is refuted by the ITA or the taxpayer. Please find below the said conditions:
- More than 50% of any kind of controlling means in the body of persons are held, directly or indirectly, by Israeli residents, at any time during the tax year or the following tax year;
- In addition, if the body of persons would not be deemed an Israeli resident, the tax liable on its profit would not exceed 15% of its total profits, and it would also be recognized as a resident of a non-treaty company or it would be deemed a resident of a treaty country but it would not be taxable on income or profits derived outside the said country.
It should also be noted that the Bill proposes imposing a reporting liability on a body of persons that claims that the above-described presumption does not apply to it, together with a requirement to attach the documents supporting its claims.
As may be discerned from the above-described provisions, the conditions set out by the legislator are based on mere technical examinations, by determining a presumption that the Management & Control is carried out from Israel, without any consideration of the essential and actual place of Management & Control. The Bill also ignores the provisions of the different tax treaties between Israel and other countries and provides that even a foreign body of persons, that may be deemed a resident of a treaty country, will be still deemed an Israeli resident, if the tax on its profit is less than 15%.
We believe that approving the provisions concerning the place of Management & Control, in its current wording, would have severe and acute consequences for thousands of taxpayers and foreign companies, including foreign investors that co-invest with Israeli tax residents. Not only would companies, in which the actual and fundamental Management & Control exists outside of Israel, be presumed Israeli resident companies, although they are essentially managed and controlled outside of Israel, but they would also be required to file annual reports to the Israeli tax authority and reports concerning their income and profits, even though they are actually managed and controlled outside Israel.
Controlled Foreign Company
Section 75B of the ITO deals with the taxation of undistributed profits of a controlled foreign corporation ("CFC"), which are deemed dividends in the hands of Israeli shareholders. Under the current wording, a foreign company would be deemed a CFC if most of its earnings or profits are derived from a passive source ("Passive Income"). Passive Income is defined as income from interest, indexation, dividends, royalties and rental income, which is not deemed income from a business or occupation if derived in Israel.
For years, the ITA has claimed that taxpayers make use of the said definition of Passive Income by classifying the income received by the foreign company as business income and thereby avoiding the application of section 75B of the ITO. The Bill is proposing amendments of the definition of Passive Income to clarify the following:
- Interest or indexation income that is received from a related party would be deemed Passive Income even if it is business income.
- Royalties would be deemed Passive Income under any circumstances, save if the income is paid due to an asset that was developed directly by the foreign company, and the payer of the royalties is not a related party.
- Rental income from an asset that was rented for a period longer than a year shall be deemed Passive Income even if the rental income qualifies as business income.
The aforementioned amendments, if enacted, will surely widen the circle of foreign companies that are deemed CFC, and levy dividend taxes on their undistributed passive profits.
The Bill includes amendments and updates of the provisions set out in section 85A of the ITO, which regularize the treatment of TP. These amendments are proposed in order to conform the Israeli tax law to the standards set by the OECD in article 13 of the BEPS concerning the documentation and reporting requirements in relation to TP and related parties transactions.
The proposed provisions concerning TP include provisions imposing reporting liabilities on companies that are entities in multinational corporations groups and on Israeli resident parent companies in multinational groups that fulfill the conditions set out in the Bill ("Parent Company"). The reporting liability applying to Parent Companies is very wide and includes disclosure of the activities and details of each company held by the Parent Company in every tax year. The exact content of the said reporting will be set out in regulations to be enacted by the Ministry of Finance.
Furthermore, the Bill provides that the tax officer will be authorized to request, from a company that is part of a multinational group of entities or a company that executed an international transaction with a related party, as defined in section 85A(a) of the ITO, and such company will be liable to provide any documents or information that are related to an international transaction, its conditions, the way its price was determined, or any information, documents or reports that are related to the multinational group of entities executing said international transaction. If such documentation is provided, the burden of proof rests with the tax officer if he wishes to deviate from the information presented by the taxpayer.
It is needless to emphasize the ramifications of the above provision and the burden of reporting that will be levied on Israeli resident companies belonging to multinational corporate groups, and also on such corporate groups.
We will publish another article updating on the final decision and wording of the Bill once the legislation procedure is finalized.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.