An Israeli resident company (“ILCo“) and other non-Israeli resident investors have founded a real estate fund (the “Fund”) in order to invest in real estate assets in several European countries. This Fund was formed as a Limited Liability Partnership (the “LLP”) according to the laws of a certain third country (State X). This LLP is a transparent entity for tax purposes under the laws of State X, meaning that it is not subject to tax and income or gains, as well as all the assets or liabilities of the LLP, are attributed to its partners. Any transfer of monies from the LLP to the partners is not a taxable event in State X and, accordingly, no withholding tax is imposed. The Fund is contemplating to invest in a real estate asset located in State Y, with which Israel has concluded a tax treaty. The asset will be held through a special purpose company (SPV) that will be established under the laws of State Y for this purpose.
The Tax Decision substantiates the right of ILCo to enjoy treaty benefits, which are provided under the tax treaty between Israel and State Y (Germany), allowing it to be credited in Israel for the underlying income tax paid by the SPV in state Y, against future dividends income tax to be imposed in Israel upon distribution of dividends to the Israeli resident shareholders.
It should be mentioned that the Israeli domestic law allows an Israeli resident company to elect the “Indirect Tax Credit” method, i.e., to be credited also for the underlying corporate income tax paid by a foreign resident subsidiary, against Israeli dividend income tax, if certain minimal holding requirements are met. In the case of ILCo, these Israeli domestic law holding requirements were not met. However, under the tax treaty with Germany a minimal holding is not required in order to enjoy the Indirect Tax Credit.
Generally, according to Israeli tax law, a partnership is treated as a transparent entity and is, therefore, not taxable (its income is attributed to the partners). Nevertheless, a controversial and prominent Supreme Court decision issued in 2001 (the Sadot case) has created a certain level of ambiguity, since it referred to the disposition of an interest in a partnership as a sale of one “holding interest” / one asset – for capital gains tax purposes. According to an Income Tax Circular (14/2003) issued by the ITA following the Sadot case, the sale of interest in a partnership is also treated by the ITA as a deemed sale of a company shareholding / one asset for capital gains tax purposes. The lack of sufficient pre-rulings in relation to partnerships left the taxpayers with this ambiguity.
As a result, the Israeli tax implications in relation to a foreign LLP within multi-national structures were unclear. This important Tax Ruling may, therefore, provide further clarity, while referring to the foreign partnership as a fully transparent entity for income tax purposes, treaties applicability and Israeli domestic tax benefits for both inbound and outbound investments structures involving foreign partnerships. For example: it may be argued that a resident of a treaty country who invests in Israel through an LLP, which was formed under the laws of a third country (with characteristics resembling those of an Israeli partnership), may still claim the benefits according to the treaty between Israel and his state of residence (as recommended by the OECD).
