In May 2015, Taxation Decision (No. 4528/15) on the subject of the date of commencement of residency in Israel, attribution of revenues of a family company owned by an eligible individual and establishing a mixed income mechanism, was published.
The facts: This case deals with spouses who immigrated to Israel from a treaty country. The applicant received his new immigrant card in late 2013 but he and his spouse barely stayed in Israel until the date on which the spouse received new immigrant status, in mid-2014. The spouses established a family company in Israel (the “Family Company”), fully owned by them, which grants services to a company that resides in a treaty country (hereinafter: the “Foreign Company”). The Foreign Company is held by the applicant at a rate of 45% and by an unrelated foreign resident. The Foreign Company engages in field of commerce and its activity has no connection with Israel. The Family Company serves as the “agent” of the Foreign Company, in exchange for a fixed percentage of the sales turnover. Prior to the applicant’s immigration to Israel, a (different) foreign company that the applicant fully owned served as an “agent” under similar conditions and it discontinued its activity shortly before the founding of the Family Company.
Professional background: The relevant article in the ITO regarding family company were amended, effective from 2014 onward, and it states that the proportion of a beneficiary individual in a family company will be entitled to benefits applying to that eligible individual (generally speaking, an exemption from tax and from reporting foreign income for a period of 10 years). Until the said amendment, it may be argued that all of the income of the family company is tax exempt rather than just the proportion of the eligible individual.
Establishing the commencement date of residency in Israel: It was determined that the date of acquisition of Israeli residency would be the date of relocation the “center of life” to Israel, rather than the date on which the applicant received his new immigrant card, in view of the fact that for six months after the date of receipt of immigrant status, the applicant did not actually reside in Israel. This is a facilitative approach that defers the commencement of the benefit period count (despite immigrant status constituting connection to Israel, primarily on the objective level). On the other hand, this approach also prevents individuals from performing a mere “fiscal immigration” (acquisition of citizenship or immigrant status, without actually relocating their “center of life” to Israel). Moreover, further to the trend of contesting on against the “fiscal immigration”, it is explicitly clarified that the decision does not constitute confirmation of residency, despite the explicit determinations therein”.
Retention of benefits within a family company: already previous decisions that were published by the ITA have stated that the benefits to an eligible individual would also be retained when the activity would be performed through a family company. However, in the current decision it was stated that the use of a family company “cancelled” the exemption from reporting the exempt incomes attributed to the eligible individual, this being naturally in order to allow for checking the manner of attribution of incomes (see below). As the ITO also states, it has been ruled that a dividend distributed from the family company would be exempt, even if distributed to the eligible individual after the end of the benefits period.
It was also determined that if the company would cease to be considered as a family company (for example due to the joining of an unrelated shareholder), all of the revenues would be taxable, including the dividend distributed from them. In our opinion, this will not prevent the eligible individual from charging the company for the incomes he generated overseas (calculated in accordance with the criteria prescribed in the taxation decision) and be exempt for those incomes, at the same time deducting the expense by the Family Company, for the fact that the payer is an Israeli company does not change the place where the income was derived (by the eligible individual) and cancel the exemption.
Establishing a mixed income mechanism: in the decision, a mechanism has been determined for attribution of the tax exempt part in Israel (i.e. the part that has been generated outside of Israel) according to the number of business days the individual resided outside of Israel relative to the total number of business days in the tax year (this approach was also prescribed in a professional circular on the subject). We should mention that the professional circular regarding the subject allows an individual not to split the income in this manner and use a different splitting method, as long as the burden of proof concerning the manner of splitting in such a case is assumed by the individual. In our experience, the economic value of the activity that is performed outside of Israel is usually much higher than that performed during the stay in Israel, and therefore, in the appropriate circumstances, it is advisable to examine economic approaches for attributing the mixed income and relying inter alia on some kind of a transfer prices study.
The decision reapplies, with greater vigor, the ITA’s approach whereby the relative exemption for mixed income will be given only if the number of business days abroad of the eligible individual was not insignificant, in which case the income of the individual would be considered as having been wholly derived in Israel. The overseas attribution will be considered as insignificant if the individual was outside of Israel for less than 60 business days per year, i.e. less than about 25% of the number of business days in the tax year! In our opinion, this interpretation is far reaching and does not correspond with the source rules concerning business income or employment income that are prescribed in the ITO or in the tax treaties to which Israeli is a party to. Moreover, even if the significant and insignificant approach and the insignificant proportion rate is accepted, we are of the opinion that this test must also be applied to the counterparty side, i.e. if less than about 25% of the income was derived in Israel according to the economic allocation as set forth above, then the entire income will be considered as having been derived outside of Israel.