On August 21, 2014, a new tax treaty was signed with Germany, replacing the previous tax treaty that was signed in the 1960s. On May 8, 2016, an order giving the treaty effect from January 1, 2017 was signed.

In preparation for the effect of the treaty and in view of the many investments that Israelis make in Germany, we summarize the implications of the new treaty and special issues related to it, as follows:

Taxes in Germany that are discussed in the treaty
The new tax treaty applies to the German income tax applying to individuals, corporate tax, capital gain tax, trade tax (also referred to as business tax) and the surcharges imposed on them (referring primarily to solidarity tax, at a rate of 5.5% of the tax). Whereas the old tax treaty also included the tax types above, solidarity tax was not explicitly stated in the old tax treaty, although according to the provisions of the ITO, to this day it may be claimed as a credit, inasmuch as it falls under the definition of “foreign taxes” in the ITO.

Rates of withholding tax from dividends, interest and royalties
Dividends: the withholding tax rate for dividends has been decreased from 25% to 10%, and in the case of an Israeli company holding at least 10% or more of the company paying the dividends, the withholding tax has been decreased to 5%.

Interest: the withholding tax rate for interest has been reduced from 15% to 5%. We should point out that by domestic law in Germany, there is no withholding tax on interest payments, with some exceptions (such as profit participating loans). According to the protocol of the new treaty, profit participating loans and similar instruments (set forth in the protocol) that may be deducted as an expense for tax purposes in the German company paying the interest, will not be subject to the reduced tax rate, but German law will apply, meaning a withholding tax at the rate of 26.375%. We should state that even after the new tax treaty takes effect, in appropriate cases and subject to the transfer pricing rules, withdrawal of profits by way of interest should be considered, despite the withholding tax, instead of holding of shares and drawing of profits as dividends, or in addition to the said holding/drawing.

Royalties: according to the new tax treaty, royalties will be taxed only in the payee’s country of residence, i.e. exemption from withholding tax in the payer’s country of residence, compared to 5% withholding tax under the old tax treaty.

Distribution from a real estate investment company:
Like most new tax treaties that Israel has signed in recent years, the provisions of the treaty mentions explicitly distribution of profits from a REIT fund, to the effect that 15% tax will be withheld from distributions received from a real estate investment fund within the meaning of Section 64A2 of the ITO and from a real estate investment company within the meaning of German law, on the condition that the investor has less than 10% of the fund.
According to German law, a German REIT fund is exempt from corporate tax and capital gain tax, while distribution from it is subject to a 26.375% withholding tax.
The combination of the provisions of the tax treaty and the law in Germany leads to a total tax (in Israel and Germany) of just 25% on profits from investment in a German REIT fund.

Indirect credit
The old treaty contains a unique provision providing indirect tax credit also for an individual (without being qualified for companies only, as is the case under Israeli law and some of Israel’s tax treaties) and without a requirement for a minimum holding rate. In the new tax treaty, the said provision has been cancelled, hence with respect to an Israeli individual who directly holds 10% or more of a German company and who has the ability to control the dividend distribution timing, it is advisable to distribute dividends early, in 2016, resulting in paying just 25% for the dividends (the withholding tax rate for dividends under the old treaty), without a need for paying additional tax in Israel due to receiving the indirect credit, instead of 30% (as a significant shareholder) effective from 2017 (in the absence of indirect credit).

In the case of an Israeli company, in contrast, it is advisable to consider delaying a dividend distribution, because the indirect tax credit is available under domestic law in any case, meaning that the relevant consideration is the decrease in the withholding tax rate (for companies only, holding 10% or more of the distributing company), from 25% to 5%. This will mean that in total (including the German corporate tax applying to the distributing company) it will pay just 25% tax for passive activity (instead of 37%, corporate tax and withholding tax for dividends in Germany according to the current treaty) and approximately 34% for business activity (instead of approximately 48% today, as above).

Timing of payments
As set forth, under the effective date clause of the new tax treaty, the reduced tax rates for interest, dividends and royalties as set forth above will apply to payments that will be made from January 1, 2017, irrespective of the date the income was generated. Thus, for example, interest accrued in 2016 but paid to a resident of Germany only in 2017 will be subject to just 5% withholding tax in Israel (and not 15% as prescribed in the old tax treaty). Therefore, in the appropriate cases, deferral of such payments until the effective date of the new provisions should be considered.

Applicability of the tax treaty to trusts
A trust falls under the definition of the term “person” without further details in the tax treaty and the protocol, and may enjoy the treaty’s benefits (like in a number of new tax treaties of Israel). In current tax treaty, there is a doubt concerning the eligibility of the trust to the tax treaty’s benefits, and in many cases there may be double taxation because the taxpayer in one contracting state is not the taxpayer in the other contracting state (for example, in one country the settlor is assessed at the time when the income is generated by the trust and in the other country, the beneficiary is assessed at the time of distribution of the income).