Israeli Tax Alerts | Practical Interpretations | 2008-2020

130 and its recent amendment are just two examples of a wide variety of government incentives for those investments. These investors are (generally) not novices who blindly invest their money without prior scrutiny; they typically engage advisors to identify potential deals, examine the financial feasibility of the company under consideration, perform due diligence and determine the best means of investment. Sometimes decisions to move forward with the investment are made by the advisors in cooperation with the investor (including in "investment committees"). Further on, investors may appoint such an advisor as their representative to the Board of Directors of the company in which they are investing, because such investors wish to be actively involved in guiding the company's strategic business decisions in order to increase its profits. These are typical activities of all rational strategic investors of a particular company, who tend to hold on to those investments for quite a number of years. An interesting taxation decision (tax ruling) published recently by the Israeli Tax Authority, stipulates that such a circle of advisors may classify the profits in a future sale of the shareholdings – as taxable profits from a business, rather than exempt capital gains! This taxation decision applies to investments in Israel by a foreign company which uses the services of a local management and advisory team. It stipulates that the investments of the foreign company in Israel and its accompanying activities establish a permanent establishment in Israel (which requires corporate tax or marginal tax rates, whichever appropriate, on its income). The method of allocation of taxable income of the permanent establishment is determined by costs (worker salary and service providers, general and administrative, et al) as per the ratio of their disbursement abroad versus locally in Israel ("the allocation mechanism"). In certain cases, the position at the basis of this taxation decision may in fact be advantageous for the taxpayer - as interest and dividends are obtained by the investors from their investment, these too are to be classified as a part of the business income of the permanent establishment and are thus also subject to the allocation mechanism. Thus, if the cost ratio indicates 90% abroad, for example, then only 10% of the interest and dividends obtained would be taxable in Israel. Nonetheless, the taxation decision agreed upon between the sides stipulates that all interest and dividend income is taxable in Israel; however from our stance it follows that this understanding contradicts the basis for the taxation decision - that is, the allocation of income to a permanent establishment in Israel (by the way, standard tax treaties also stipulate that taxation clauses that apply to interest and dividends shall not apply to