Below we shall review, in brief, the provisions of the tax treaty with Panama, which will enter into force from the 2015 tax year,  and the new tax treaty which has been signed (but not yet ratified) with Germany.

The Tax Convention with Panama

As is well known, the tax system in Panama is primarily territorial, both with regard to individuals and also with regard to companies. In principle, the treaty is based on the OECD Model Convention, and the main provisions of the convention are as set forth below:

1. Residency – the first tie-breaker test with regard to individuals is the test of the permanent home (similar to the OECD Model Convention). With regard to an entity, which is not an individual (including a company and a trust), attempts should be made to determine the issue of double residency by proceedings of mutual agreement based on the place of effective management. The residency section and the protocol to the convention include specific reference to trusts. In the protocol, it is determined that in their attempt to determine the domicile of a trust for a certain period of time, the competent authorities will take into account all of the relevant factors (the trust law, the location of the trust’s assets and the residency of the relevant individuals in the trust).

2. The withholding tax applied to dividends is, as a rule, at the rate of 15%. In addition, the imposition of branch tax up to the rate of 5% is permitted. We shall note that according to the domestic law in Panama, a branch tax at the  rate of 10% is levied on permanent establishments, whereas Israel currently does not levy branch tax.

3. The withholding tax applied to  interest and royalties is, as a rule, at the rate of 15%.

4. Capital gains from the sale of shares: the first taxation right is reserved for the country of source in cases of ownership of over 50% of the company being sold (in such a case, the tax is limited to a rate of up to 5%); in other cases, as a rule, the taxation right is reserved only to the country of the shareholder’s residency. We shall note that with respect to capital gains which have accrued for a resident of Panama from the sale of shares of an Israeli company, the provisions of section 97(B3) of the ITO prevail, which grant a full exemption (also in case of  holding more than 50% in an Israeli resident company), provided that the terms and conditions of the section have been fulfilled.

5. With regard to other income (which is not discussed in other sections of the Convention), an exclusive taxation right is granted to the country of residence, provided that the entity producing the income is subject to tax on it in the said country.

The Effect of the Convention with Panama on the Provisions Which Exist in the Israeli Law:

1. The Convention includes an ‘Exchange of Information’ section, as exists in other conventions. It follows that the State of Israel will be able to receive information which exists in connection with Panamanian companies (and vice versa). We shall note that according to the Convention, information may be requested retroactively in relation to a period of three years prior to the date of the Convention entered into force, that is to say – from the beginning of 2012. Beyond the foregoing date, we shall note that in recent years, the subject of exchange of information has been a dynamic issue, and the rules of information exchanges are due to change in the coming years, among other reasons, in view of the “Multilateral Convention on Mutual Administrative Assistance in Tax Matters”, which Israel is likely to join in the near future.

2. Shareholders who hold or purchase shares of Panamanian companies at a rate of 25% or more will not be required to file Form No. 1213, regarding tax planning subject to reporting.

3. The calculation of the taxable income of a Panamanian company, pursuant to the implementation of the provisions of the ITO with regard to CFC or with regard to a Vocation Company, will be based on the tax laws in Panama, and not on the provisions of the ITO, as have been in effect until the present day, and subject to the exclusions set forth in the ITO.

The New Convention Signed with Germany

In August 2014, a new convention was signed with Germany, which replaces the previous convention which was signed in the 1960s. The convention has not yet been ratified by the parties,

and in the event that it is ratified before the end of 2014, then its provisions will enter into force from January 1, 2015. The new convention is based on the OECD Model Convention. Below are the significant changes which have been introduced into the new convention as compared with the current convention:

1. Dividend and Distribution from a Real Estate Investment Company

The withholding tax applied to dividends has been reduced from a rate of 25% to 10%, and in case of holding at least 10% in the company paying the dividend – 5%. In addition, the provisions of the Convention make reference to a Real Estate Investment Funds, so that a withholding tax applied to distributions from such funds (as defined in the ITO or in the German law), at a rate of 15%, provided that the investor holds less than 10% of the fund.

2. Cancellation of the Indirect Credit Mechanism:

The indirect tax credit for individuals and for companies, which exists in the current convention, has been cancelled, which means that when the new convention will enter into force, the narrower provisions of the ITO will apply (according to which the indirect credit will be granted only to companies, provided that there is a holding of 25% or more). Consequently, the stated below shall apply with regard to a person who possesses the ability to control the timing of the dividends distribution: with regard to an individual who is a significant shareholder (who holds 10% or more) in a German-resident company, it is recommended to precede the dividends distribution so that he will only pay 25% tax on the dividend in Germany (without being required to pay the supplemental tax in Israel, following the indirect credit mechanism in the current convention) instead of 30% in the following year (in the absence of the indirect crediting). With regard to an Israeli company (which holds 25% or more), on the other hand, it is recommended to consider delaying the dividends distribution, because indirect credit does exist in respect thereof according to the domestic law, and therefore, the relevant consideration is the reduction of the withholding tax from the rate of 25% to 5%. In this manner, in total, (including the German corporate tax which applies to the distributing company) 26.5% will be paid by it in respect of passive activities (instead of 37% at the present time) and approximately 34% will be paid by it in respect of business activities (instead of approximately 48% at the present time).

3. Interest

The withholding tax levied on interest has been reduced from a rate of 15% to 5%. According to the domestic law in Germany, there is no withholding tax levied on interest payments, except in exceptional cases (such as a profit-sharing loan, see below). In accordance with the protocol to the new convention, the reduced withholding tax rate will not apply to profit-sharing loans and similar instruments (as set forth in the protocol), which are deductible at the German company paying the interest, but rather, the German law will apply thereto. in other words, the withholding tax will be at the rate of 26.38%. We shall note that even after the new convention will enter into force, in the appropriate cases and subject to the rules of transfer prices, it is advisable to consider the option of interest-bearing financing, inspite of the withholding tax rate, instead of the withdrawal of profits as a dividend.

4. Royalties

According to the new convention, income from royalties will be taxed only in the country of domicile of the recipient of the payment, as compared with a withholding tax at the rate of 5% which is stated in the current convention.

5.   A “trust” is included in the definition of the term “person”, without giving additional details in the convention or in the protocol, and a trust may benefit from the benefits of the convention (as is the case in a number of new conventions). In the current convention, there is a doubt with regard to the trust’s eligibility per se to the benefits of the convention, and in many cases, double taxation may arise because the taxpayer in one contracting state is not the taxpayer in the other contracting state (for example, in one contracting state, the settlor is taxed at the time when the income is derived by the trust, and in the other contracting state, the beneficiary is taxed upon receiving distribution from the trust’s income).