We wish to bring to your attention some of the expected significant changes in the Israeli tax legislation, concerning two of the main international anti-abuse provisions – Controlled Foreign Companies (CFC) and Foreign Vocation Companies (“FVC”). The expected proposed changes are set forth below in summary format (as stated below, those are proposed changes only):

1. Controlled Foreign Company:

1.1 Within the proposed changes in the provisions applying to a controlled foreign company (CFC), amendments are proposed, which are intended inter alia to cope with issues to which the Tax Authority has been exposed since the introduction of the CFC regime in 2003. The relevant set of rules states that a controlling shareholder (an individual or a company that is a resident of Israel, holding at least 10% of the controlling interest) in a CFC will be subject to tax for its share in the undistributed profits of the CFC at the end of the tax year as though it had received them as a dividend (deemed dividend). The provisions relate to profits that originate from passive incomes of the CFC, upon which the imposed foreign tax has not exceeded 20%. The proposed changes to the CFC provisions are set below:

1.2 The tax rate threshold to which the CFC provisions will not apply has been decreased from 20% to 15%. In this case, a number of countries in which income is subject hitherto to the CFC rules in Israel, will be excluded from the Israeli CFC regime, including: the Czech Republic (19%), the Netherlands (20% for an income that does not exceed 200,000 euro), Poland (19%), Hungary (19%), Germany (approximately 16%), Great Britain (20% for an income that does exceed 300,000 pounds).

1.3 According to the law currently practiced, the taxable income of the Israeli controlling shareholder is calculated according to the tax laws of the CFC country in the case of a company that resides in a foreign country with which Israel has signed a tax treaty (a “treaty country”), and in other cases, according to the generally accepted accounting principles. Pursuant to the amendment, in the case of a CFC residing in a treaty country, the taxable income will still be calculated according to the tax laws of that country, but the following amounts will be added: (A) dividend or capital gains that have been exempted from tax or that are excluded from the tax base according to the laws of that country (unless if resulting from a re-organization or asset exchange) and (B) specified amounts that have been deducted for tax purposes in that country that are not recognized as an expense or as a deduction according to generally accepted accounting principles (basically deemed expenses). The meaning of the amendment is that a participation exemption regime for example, or deemed interest expenses will no longer decrease the profit based on which the controlling shareholder of the CFC is taxed. In countries with which Israel has no treaty, the income will be calculated according to the tax laws applying in Israel (and not according to the accounting principles as has been the case heretofore).

1.4 Within the amendment, the provisions for deemed foreign tax credit when taxing a controlling shareholder of a CFC have been cancelled (for example, the tax that would be withheld at source in the country of the CFC when profits distributed as a dividend would no longer be credited from the tax applying to that deemed dividend). Instead of this, at the time of actual dividend distribution, or sale of shares, the tax that was paid in excess may be refunded to the controlling shareholder.

2.     Foreign Vocation Company:

2.1 In 2003, an anti-abuse provision was enacted, intending to prevent Israeli individuals from avoiding tax in Israel when performing vocation activity (e.g., commissions and management fees) within the framework of a foreign company. This provision prescribes a “source rule”, whereby income that a Foreign Vocation Company generated will be considered as an income produced in Israel, even if the business activity or service is actually performed or provided outside of Israel. The part that is subject to tax in Israel pursuant to this provision is limited to the Israeli shareholders’ share. Since it was introduced, this regime was controversial, as the tax authorities in Israel asked to apply it to companies residing in treaty countries. Owing to this, the Bill is aiming to change the Foreign Vocation taxation mechanism by taxing the shareholder instead of the company.

2.2 It is proposed that deemed dividend income will be attributed to the shareholder in a Foreign Vocation Company, in accordance with his share in the profits from the special vocation activity (similar to the CFC regime). The tax rate imposed on such deemed dividend will be the corporate tax rate, with a foreign tax credit for the Corporate Income Tax paid by the Company in its residence country.

2.3 The taxation above will be in addition to the dividend taxation applying to the shareholder at the time of distribution of an actual dividend from the Foreign Vocation Company, according to the ordinary tax rates applying to dividend from a foreign company (25% or 30%), meaning that in the end, the effective taxation of the shareholder of a Foreign Vocation Company will be similar to the taxation of a shareholder in an Israeli company.