Tax Alert No. 14 - 20.9.2012

We deem it appropriate to update our colleagues and clients, in this news bulletin, regarding a number of legislative processes and temporary orders which are relevant at the present time.

1. Raising Taxes

• The rate of VAT has been raised up to 17% (instead of 16%), effective from September 1, 2012.

• In August 2012, the Law for the Reduction of the Deficit was published, in which it was determined, inter alia, that commencing from January 1, 2013, additional tax would be imposed at a rate of 2% on the taxable income of an individual which exceeds NIS 800,000 (approximately US$ 200,000). For the purpose of the imposition of the additional tax, inflationary amounts and remuneration from an exempt sale of a residential apartment, shall be excluded out of the taxable income. With regard to chargeable appreciation tax on a residential apartment’s sale, the additional tax shall be imposed only if the amount of the sale exceeds NIS 4 million (approximately US$ 1 million). The additional tax shall also apply to amounts of income spread over consecutive years in which the income was generated (for example – the spread of a retirement bonus), in each one of the years of the spread.

• We shall recall that in the course of previous legislation for a modification of the tax burden, which took effect commencing from January 1, 2012, the rates of tax applicable to capital gains, dividends and interest were increased to a rate of 25% (instead of 20%). With regard to capital gains and dividends received by a significant shareholder (a shareholder who holds 10% or more of the rights in the Company), the rate of tax was increased to 30% (instead of 25%). In addition, in the same legislation, the rate of corporate tax was set at 25%, and the outline for the graduated decrease of the CIT was cancelled, at the end of which the rate of tax in the year 2016 was supposed to be 18%.

2. Voluntary Disclosure

As previously reported, a temporary order for voluntary disclosure of overseas assets and income, which was published on November 15, 2011, grants concessions at the level of the collection of tax – an exemption from interest and fines on the applicable tax, and the possibility of the cancellation of linkage differentials.

On June 26, 2012, an extension was published for the submission of applications for voluntary disclosure pursuant to the temporary order, in which the possibility was also granted of making an application to the tax authority, anonymously, so as to clarify the tax liability as arises from the facts in the case, before exposing the applicant’s name.

As of the date of the writing of this Bulletin, no additional extension has been published, and the final date for the submission of applications for voluntary disclosure pursuant to the temporary order is September 27, 2012. The Tax Authority has agreed to receive applications which do not contain documentation at the stage of the submission of the application, whilst granting the possibility of the submission of all of the relevant documents at a later date.

After the said date, applications for voluntary disclosure may be submitted pursuant to the “regular” fixed procedure (which was published in 2005). It shall be noted that the later procedure does not include concessions at the level of the collection of tax, and it does not include the possibility of making an anonymous application to the Tax Authorities.

3. Encouragement of Distribution of Profits – Temporary Order

On August 6, 2012, a Bill was published to amend the Law for the Encouragement of Capital Investments (hereinafter: the “Law”), which determines a temporary order for a period of one year from the date of the publication of the Law, once it shall be amended, pursuant to which a company which has accumulated tax-exempt profits pursuant to the Law may distribute them or may release them, whilst receiving a discount from the corporate tax which should have been paid at the time of the distribution (hereinafter: the “Released Profits”). The rate of the discount ranges between 30% to 60% out of the “regular” tax which should have been paid, as detailed below: Pursuant to the regular provisions of the Law, many companies benefited from an exemption from corporate tax on their qualified profits. However, the exemption is a temporary exemption, up until the date of the distribution of the qualified profits as a dividend. At the time of the distribution, the said companies are required to pay the corporate tax which was deferred at the rates which range between 10% (in the event of a company with a foreign ownership of 90% or more) and 25% (a “regular” company). Due to these provisions, many companies refrained from distributing their accumulated profits and according to an estimate made by the Israeli Tax Authority, this matter concerns accumulated profits in a total amount of approximately NIS 100 billion (approximately US$ 25 billion).

According to the temporary order, companies which wish to do so, may release the profits which have accumulated thereat by December 31, 2011, by paying a reduced rate of corporate tax, as aforesaid; there is no need to make an actual distribution of the said profits. At the time of a future distribution of the said profits which have been released, no additional corporate tax shall apply, but only the tax on the dividend (at a rate of 15%, subject to tax treaties’ provisions).

The rate of the discount (as aforesaid, a discount ranging between 30% and 60%) shall be determined linearly in accordance with the proportion of the released profits out of the amount of the accumulated profits. Thus, if the full amount of the accumulated profits is released, the rate of the discount from the tax is 60%, provided that the rate of the tax after the discount shall be not less than 6%.

The Bill does not include stipulations with regard to the manner of the use of the Released Profits, however we shall note that in light of the discussions of this matter at the Knesset Finance Committee, it is possible that terms and conditions shall be determined regarding the designation of the Released Profits for growth-generating investments in Israel.

The provisions of the Israeli Income Tax Ordinance (hereinafter: “ITO”) make the offsetting of a capital loss contingent upon the situation whereby had there been a profit, it would have been liable to tax. This stipulation is a basic principle in all matters pertaining to the possibility of the offsetting of losses, also with regard to losses from current income. Furthermore, a foreign resident is exempt from tax in the sale of shares of an Israeli company by virtue of the provisions of the ITO (with regard to shares that were purchased commencing from January 1, 2009) or the tax treaty with the country of the vendor’s domicile, provided that the matter does not concern shares of a company whose main value is attributable to real estate in Israel, or profits attributed to a permanent establishment of the vendor in Israel.

In a law which has been recently enacted in Israel, known as the “Angels Law”, a special and precedent-setting statute has been determined which allows, upon certain conditions, the deduction of the cost of the investment in Israeli start-up companies as a regular expense, against any source of income, up to an investment amount of NIS 5 million in each company (approximately US$ 1.25 billion). The Angels Law applies to investments made in “target companies”, effective from the 2011 tax year and up until the expiration of the 2015 tax year. A “target company” is a company which meets the conditions set forth in the Law, and basically, it concerns start-up companies at the very initial stages, whose main engagements and expenses during the period of the benefits (three years, commencing from the year of the investment) are research and development, most of which is performed in Israel.

The special statute determined in the said Angels Law also applies to a foreign resident, even though this is a person who would be exempt from tax in Israel on profit from a future sale of shares in a target company, and were it not for the Angels Law, he would not be entitled to deduct or reduce the cost of the shares for tax purposes in Israel as against any item of income. Clearly, the very fact of the deduction of the expense by the foreign resident does not deny him the exemption in the sale of the shares, which is conferred, as aforesaid, pursuant to the ITO or the relevant tax treaty. This interpretation has also been given specific expression in the Income Tax Circular discussing this matter.

Below is an example to demonstrate the benefits with regard to a foreign resident: a foreign-resident individual intends to sell, in 2012, real estate which he owns to an Israeli venture, for a profit of NIS 5 million. Such a profit held by a foreign resident is liable to tax in Israel, also in accordance with the provisions of the tax treaty (which grants a first taxation right to the country in which the real estate is located). The said individual may invest in the shares of a “target company” in such a manner and upon such terms and conditions as included in the Angels Law, an amount of NIS 5 million. The said investment amount shall be deducted from the profit from the sale of the real estate, so that no appreciation tax whatsoever shall be paid. In the future, and not prior to December 31, 2014(namely the last year for the period of the benefit set forth in the Angels Law, and during which the shares of the target companies shall be held), the individual may sell his shares in the target company with a full exemption from tax, without any restriction in amount.

We shall mention that the possibility of benefiting from the exemption on the sale of the shares also exists if the foreign resident comes to Israel and acquires the status of a “new immigrant” or an “old returning resident” (a person who returns to Israel after at least 10 years during which he was a foreign resident), in accordance with the provisions of the ITO, which preserves the exemption in such case.

An income tax circular which was published by the Income Tax Authority in Israel (hereinafter: the “ITA”) sets forth criteria for the Tax Assessor at the time of determining an assessment for a taxpayer who does not possess the reference documents to substantiate the existence of any particular expense or the cost of any particular asset, and the amount thereof.

In the general background for the Circular, the ITA determines the following:

“In cases where there are no documents to show the existence of an expense or to prove the cost of an asset, for the purpose of the determination of the taxable income, this shall not constitute an impediment to the claim and recognition of the expense or the cost of the asset.”

The Tax Assessor shall permit the taxpayer to deduct such expense, once he has been satisfied that it indeed incurred in accordance with the circumstances of the case, whilst examining the nature and the purpose of the expense.

Inter alia, the Tax Assessor is required to examine the amount of the payment actually made in respect of the expense, to identify the receiving party and the means of payment thereto (and also the identification of the recognition of the income by the receiving party / the customer). In addition, the Tax Assessor shall examine other relevant documents pertaining to the requirement of the deduction of the expense, such as: agreements and contracts between the parties, an appraisal or other documents substantiating the value of the asset, the records of administrative authorities, affidavits of the parties, and so on and so forth.

Insofar as the taxpayer fails to comply with the burden of proof as stated above, the Tax Assessor shall assess the expenses and the taxable income of the taxpayer based on economic reviews, hypotheses and estimates as per standard practice in the industry in which the taxpayer is engaged, and pursuant to the guidelines of the ITA for examining the reasonableness of the income. The welcome provisions arising from this Circular perpetuate the trend, as can be seen in recent case laws in Israel, in all matters pertaining to the justification that is required from the Tax Assessor when he comes to increase the assessment, in cases where the taxpayer’s books have been properly kept.

In our opinion, it is necessary to adopt the provisions of this Circular also for the examination of the deductible expenses and costs at the time of the calculation of land appreciation pursuant to the Real Estate Taxation Law, even in the absence of such documentation, and also at the time of the examination of the increase in the taxpayer’s assets and capital, for tax assessment’s purposes.

The provisions of the Israeli Income Tax Ordinance (hereinafter: “ITO”) make the offsetting of a capital loss contingent upon the situation whereby had there been a profit, it would have been liable to tax. This stipulation is a basic principle in all matters pertaining to the possibility of the offsetting of losses, also with regard to losses from current income. Furthermore, a foreign resident is exempt from tax in the sale of shares of an Israeli company by virtue of the provisions of the ITO (with regard to shares that were purchased commencing from January 1, 2009) or the tax treaty with the country of the vendor’s domicile, provided that the matter does not concern shares of a company whose main value is attributable to real estate in Israel, or profits attributed to a permanent establishment of the vendor in Israel.

In a law which has been recently enacted in Israel, known as the “Angels Law”, a special and precedent-setting statute has been determined which allows, upon certain conditions, the deduction of the cost of the investment in Israeli start-up companies as a regular expense, against any source of income, up to an investment amount of NIS 5 million in each company (approximately US$ 1.25 billion). The Angels Law applies to investments made in “target companies”, effective from the 2011 tax year and up until the expiration of the 2015 tax year. A “target company” is a company which meets the conditions set forth in the Law, and basically, it concerns start-up companies at the very initial stages, whose main engagements and expenses during the period of the benefits (three years, commencing from the year of the investment) are research and development, most of which is performed in Israel.

The special statute determined in the said Angels Law also applies to a foreign resident, even though this is a person who would be exempt from tax in Israel on profit from a future sale of shares in a target company, and were it not for the Angels Law, he would not be entitled to deduct or reduce the cost of the shares for tax purposes in Israel as against any item of income. Clearly, the very fact of the deduction of the expense by the foreign resident does not deny him the exemption in the sale of the shares, which is conferred, as aforesaid, pursuant to the ITO or the relevant tax treaty. This interpretation has also been given specific expression in the Income Tax Circular discussing this matter.

Below is an example to demonstrate the benefits with regard to a foreign resident: a foreign-resident individual intends to sell, in 2012, real estate which he owns to an Israeli venture, for a profit of NIS 5 million. Such a profit held by a foreign resident is liable to tax in Israel, also in accordance with the provisions of the tax treaty (which grants a first taxation right to the country in which the real estate is located). The said individual may invest in the shares of a “target company” in such a manner and upon such terms and conditions as included in the Angels Law, an amount of NIS 5 million. The said investment amount shall be deducted from the profit from the sale of the real estate, so that no appreciation tax whatsoever shall be paid. In the future, and not prior to December 31, 2014(namely the last year for the period of the benefit set forth in the Angels Law, and during which the shares of the target companies shall be held), the individual may sell his shares in the target company with a full exemption from tax, without any restriction in amount.

We shall mention that the possibility of benefiting from the exemption on the sale of the shares also exists if the foreign resident comes to Israel and acquires the status of a “new immigrant” or an “old returning resident” (a person who returns to Israel after at least 10 years during which he was a foreign resident), in accordance with the provisions of the ITO, which preserves the exemption in such case.