Company Residency – In which cases the Israeli Tax authority will determine that a company that has incorporated abroad is a resident of Israel for Tax purposes?
The Israel Tax Authority looks carefully at companies that have incorporated abroad for determination of the tax regime that will apply on them, Whether those companies are registered abroad for tax purposes or whether they are Israeli resident companies.
Using the Income Tax Ordinance [New Version] 5721 – 1961, the Tax Authority wishes to ensure that in cases where the company is registered abroad, but the primary place of operation is in Israel, the company will be treated as an Israeli resident. In addition, in some cases, the Israeli Tax Authority Treats companies as a “foreign occupational company”, or as a “controlled foreign company (CFC)”.
It’s advised to consult with an international taxation specialist to verify if the company that was set up abroad is not considered an Israeli resident company for Tax purposes. Our office performs optimal Tax planning that includes a chain of holding companies worldwide. The regulation of the legal situation in terms of tax liability in Israel and other countries is carried out by experts’ opinion report, and in some cases “Pre-Ruling” procedure – A preliminary agreement with the Tax Authority that determines the company’s residency and the relevant tax aspects.
Nimrod Yaron & Co advises accounting firms, lawyers, and private clients, regarding reports of foreign companies in Israel. It’s important to keep in mind that an Israeli resident who owns a foreign company is obligated to fill out the Israel Tax Authorities Form 150 and declare his possessions. Our firm adjusts the tax planning in accordance with the forms and reports of the Tax authorities.
Control and Management tests
When a company is incorporated abroad, the Tax Authority will first and foremost examine the company through the control and management test. The test is intended to see where the company’s actual activity and decision-making process are carried out – whether in Israel or in a foreign country.
In accordance with the 4/2002 “guidelines for the control and management test”, in cases which a double tax treaty (DTT) is in force between the relevant countries, the formal legal ownership of the business is not sufficient to prove and determine the residency of a company, but where its effective management is exercised, which in this case, The guidelines of the control and management test to identify the residency of a company should be examined: the whereabouts of the decision-making process of the company.
Among the questions that should be asked to determine whether a company is a resident of Israel or a foreign resident:
- Whereabouts of the decision-making process;
- Whereabouts of the director’s activity;
- Whereabouts of the person who makes the decisions in the company / the officer;
- What is the governing language;
- Whereabouts of the production/meetings with customers/activity;
- Whereabouts of the ledgers;
- Whereabouts of the employees;
- Whereabouts of the company’s offices and assets;
- Whereabouts of the company’s various consultants and service providers;
- Place of the Company’s Reports to the Authorities;
- Residency of the actual controlling shareholders of the company.
- Management contracts with external parties, such as management companies, should be examined as part of the question of control and management.
To the extent that the answers to the above questions indicates that the effective management of the company is in Israel, the Tax Authority will recognize the company as a resident company of Israel for tax purposes.
Existence or absence of a permanent establishment in Israel
The law states that tax should be taxed in Israel even if a company with permanent establishment in Israel has a foreign residency, and that the trade relationship between the foreign resident company and related entities in Israel with revenues from that activity, takes place.
Foreign corporation revenue from providing services to Israeli residents is liable for income tax if produced in Israel. Suppose the foreign corporation is a resident of a country with which the State of Israel has an agreement to prevent double taxation (DTT), the foreign corporation will be taxed in Israel only if its activity has reached a “permanent establishment”.
A permanent establishment is defined in the convention as “a fixed place of business through which the business of an enterprise is wholly or partly carried on“, or when the enterprise’s activity in Israel is carried out through an agent who has the authority to enter into contracts on behalf of the enterprise.
In light of the changes that have taken place in the “traditional” economy and the transition to a “digital” economy, the Income Tax Circular from 2016 clarifies that a permanent establishment can exist in Israel when the economic activity of the foreign corporation at a permanent place of business in Israel is carried out mainly through the Internet, and that additional conditions are met, such as: representatives of the foreign corporation are involved in locating Israeli customers; Collecting information and managing the customer relations of the foreign corporation; The service provided on the Internet by the foreign corporation is adapted to Israeli customers (language, style, currency, etc.).
Business activity that meets the requirements of the “permanent establishment” test, applies the foreign resident (the owner of the permanent establishment) the obligation to report to the tax authorities and to pay tax on the profits attributed to his activity associated with the permanent establishment, in the country where he conducts his business. If the income was generated through the permanent establishment, the country of origin has a primary right of taxation regarding the business profits, and the country of residence has a residual right of taxation.
Determine if a Company is a Controlled Foreign Company (CFC)
Section 75(b)(1) of the Income Tax Ordinance states that a controlling shareholder of controlled foreign company with unpaid profits will see him as having received his relative share of the profits as a dividend.
The Tax Authority will define a company as a controlled foreign company when the following conditions are met:
- A company incorporated abroad;
- Held by a controlling shareholder;
- The rights are not listed for trading on the Tel Aviv stock exchange (TA SE);
- Accumulate unpaid profits and the tax rate applicable to them in the country of origin does not exceed 15%;
- The tax rate on dividends does not exceed 15%;
- Most of the revenue is passive;
- More than 50% are held by an Israeli resident with the right to prevent decision-making.
Determine if a company is a Foreign occupational Company
The Israel Tax Authority can tax the international revenues of a foreign company if it is found to be a foreign occupational company. In accordance with Section 75b1 of the Tax Ordinance, a foreign occupational company is a company with foreign residency, whose more than 75% of its shareholders are residents of Israel and whose income derives from a “special occupation“- an occupation or profession designated by the Minister of Finance with approval by the Knesset Finance Committee.
List of conditions:
- A foreign resident company;
- Controlled by up to 5 people;
- 75% or more of one or more of the means of control in it are directly or indirectly held by Israel residents;
- The controlling shareholders who hold 50% or more are engaged in the special occupation;
- Most of the company’s revenue or profits in a fiscal tax year comes from the special occupation;
- The special occupation is which of the following categories:
security; agronomy; architecture; arts and crafts, including art creation; promotion, acting; singing and entertainment; Astrology, graphology and the occult; criticism including quality and quality criticism; modeling; teaching, guidance, training, including giving lectures; engineering; veterinary medicine; creating computer hardware, operating computer hardware and handling computer hardware; computer programming; investigations; aviation and sailing; telecommunications; Representation of a specialist; consulting, including in the financial, personal, security, agricultural, technical, engineering, organizational, administrative, political, scientific, taxation, business, economic fields; economics; writing and composing; scientific research and development; Management, including management of portfolios, investments or assets, management of companies, management of organizations, institutions, commercial entities including in liquidation, bankruptcy or assembly proceedings Properties; Statistics; Sports; Journalism and Editing; Advertising and public relations; law practice, drafting patents, representation before judicial tribunals; Photo; Accounting; medicine, psychology, physical therapy, dentistry, providing medical and paramedical services, alternative medicine, treatment of developmental disabilities; religious services; appraisals; mediation; translation; communication, staging, production and editing.
7. Unpaid accumulated profits.
For consultation regarding the Tax liability in Israel on the profits or revenues of a foreign company, it is recommended to contact our office. As part of the consultation, we will check compliance of the conditions, and recommend the correct course of action: opinion report; agreement with the tax authority, etc. We will also advise as to the correct reports that should be included in the financial statements, including form 150, annotations, etc.
