A foreign resident company (hereinafter: the “Foreign Company“), which is interested in operating in Israel may operate by setting up an Israeli company or through a branch that will be classified as a permanent establishment (hereinafter: a “PE“).
If the Foreign Company were to operate in Israel through an Israeli company, the Israeli company would be liable to tax on its income generated or derived, irrespective of the place it was generated or derived (taxation on a worldwide basis), whereas the PE in Israel will be taxed only on income and profits that are attributed to it (usually incomes that were generated in Israel that are related to that PE).
An example of this is a case in which the Foreign Company establishes a R&D center in Israel, which is operated through a PE.
What would be the case for a R&D center being transferred outside of Israel to another country, including key personnel, assets (including intangible assets) and know-how? Will taxes be imposed in Israel at the time of transfer of the said R&D center?
As a rule, the sale of activity and assets owned by the PE to a third party is a tax event that is taxable in Israel, and usually also in view of the provisions of the standard tax treaties.

In contrast, at the time of relocating the PE outside of Israel, the activity and assets continue to be owned by the Foreign Company, for these did not leave its possession but only relocated, and therefore there is no “sale” event.
It would seem that since no event has occurred at the geographic relocation of the PE, not even an deemed one, the sale of the activity and assets by the Foreign Company in the future would not be taxable in Israel because at the time of sale, these do not constitute the assets of a PE in Israel.
May it be argued that the PE should be considered an independent financial entity and be treated as a company for tax purposes?
One option under this interpretation would hold that a change in geographic location constitutes a change of residency of the virtual company (if for this purpose the PE will be classified as a “virtual company”), in which case Section 100A of the ITO, which prescribes provisions concerning exit tax will apply. Thus later, at the time of sale of the assets of that company, the linear mechanism prescribed in Section 100A will apply and part of the capital gains will be taxed in Israel. We shall state that in general, Section 100A of the ITO prescribes provisions concerning deemed sale of the assets of a person – a natural person or a company – on the day on which he ceases to be an Israeli resident. The section prescribes two alternatives for taxation- taxation on the date on which the person ceases to be an Israeli resident in accordance with the market value of the assets, or deferral of payment of the tax to the date on which the assets will actually be sold, with linear taxation of the part of the capital gains taxable in Israel, and all subject to conditions prescribed in the section.
Another option under this interpretation would hold that the transfer of the R&D center constitutes an event of sale from that virtual company (the PE) in Israel to another virtual company- residing outside of Israel (another PE of the same Foreign Company), and maybe also an deemed dividend distribution to the virtual shareholder (the Foreign Company) of that virtual company, all in view of the position of the ITA that was published on the subject of a change of business model in companies operating in the technology field and the applicable tax consequences.
In our opinion, there is no room for interpretations of this kind and a PE is not to be considered a separate legal entity and therefore in our opinion, the transfer of a PE from Israel will not be considered a tax event that is taxable in Israel.
In addition, even if it were argued that such a transfer of assets and activity from Israel constituted a capital event, such argument that the deemed capital gain was distributed as a dividend in kind would mean imposition of branch tax in Israel, and the ITO does not impose such taxes in Israel on current taxable income or at the time of transfer of profits from a local branch to outside of Israel.