Tax Alert No. 9 - 16.12.2010

2010 marks the accession of Israelto the OECD as a full member. This reinforces Israel’s global position economically as well as in other fields. As part of this process, Israel joined the OECD anti-bribery convention and amended its tax legislation to deny as expenditure any payment that may reasonably constitute a criminal act (for more information see tax news alert No. 6) As an OECD member, and for several years prior to that, Israel is committed to expand its network of bilateral tax treaties, in order to boost international trading while ensuring an on-going exchange of fiscal information with other countries. These are among the major goals of the organization within the taxation and anti-laundering fields. In this respect we may note two of the new tax treaties that came into force during 2010 – a treaty with Denmark (replacing an old treaty) and a treaty with Estonia (for more information see tax news alert No. 7). Both reinforce Israel’s declared intentions of following the OECD Tax Treaty Model, especially with regards to lowering or annulment of tax withholding at source form dividends, interest and royalty payments. The treaty with Denmark also includes a mutual commitment by the contracting states to assist in collection of taxes. This clause, however, will only be effective when another treaty of Israel which includes a similar commitment will come into force (none yet). Furthermore, the Israeli taxes authority has recently expressed the intention to start treaty negotiations with off-shore jurisdictions, especially with regards to exchange of fiscal information. This position corresponds with a wider trend of many countries to accomplish agreements with off-shore jurisdictions as part of a global combat against money laundering and fiscal offences. It seems that Israel has taken a big step forward in those fields as well.

Several months ago, a new treaty for the avoidance of double taxation, was initialed by and between Israel and Austria. The new treaty sets lower withholding tax rates compared to the current treaty in force. The new treaty will be in force following the formal signing and ratification procedures by both states.

Dividends

According to the new treaty, there will be no withholding tax (“WHT“) from dividends paid by a company, resident of a contracting state, to a company that is a substantial share holder (holding 10% or more), and a resident of the other state; in all other cases, the WHT rate will not exceed 10%. We may note that the current treaty sets a WHT rate of 25% from dividends. For that reason, Austrian companies were used by Israeli residents as a buffer for avoiding possible taxation of “deemed dividends” according to Israeli CFC legislation. In light of the new tax rates aforementioned, passive income derived by an Austrian company (taxed at a low rate) may be exposed to Israeli taxation imposed on an Israeli controlling shareholder.

Interest

According to the new treaty there will be a WHT rate of only 5% on interest paid to a resident of the contracting state by a resident of the other. This compared to 15% rate that is imposed by the current treaty. It should be noted that according to the law in Austria there is no withholding tax rate on interest payments.

Royalties

The new treaty follows the OECD model by setting an exemption from WHT by the source state on royalties paid to a resident of the other contracting state. The current treaty sets a WHT of 10% on royalty income, excluding royalties from Movies played in theaters or on T.V. the latter are exempt from tax. We may note that other tax treaties recently signed by Israel also follow that rule by allocating the taxation right of royalties to the state of residence.

Trusts

We expect that the new treaty will refer to the taxation of trust, in a similar manner to what was determined in other treaties Israel has signed lately (example: U.K, Denmark and Belgium). This, in order to avoid double taxation situations arising from a possible dual tax residence of a trust.  This has great importance, especially in light of the recent Israeli tax legislation regarding trusts.

Following the budget discussions in Israel for 2011-2012, a major reform in the Law for Encouragement of Capital Investment (hereinafter: “Encouragement Law”), is expected. Once approved, the encouragement law will be changed dramatically in order to enhance Israel’s economic activity and employment. The major changes in the law are brought to you as follows:

Lower company income tax (CIT) for “A Preferred Company”– an Israeli company conducting industrial activity will be entitled to be taxed at a CIT that is lower than the normal CIT (as of 2011 – 24%, gradually declining towards 18% in 2016). the activity must be conducted through “a competitive plant”, as defined by the law. the CIT rate for “A Preferred Company”  is determined based on the location of the plant as follows:

      Development zone A– 8%;

      The rest of the country – 12%.

According to a temporary provision – for tax years 2011-2012 the CIT rates shall be 10% and 15%, respectively. (Jerusalem is defined as development zone A).

Tax on dividend distribution from “A Preferred Company“: dividends paid to an individual shareholder will be taxed at a final rate of 15%, subject to a lower rate set in a tax treaty.

Scope of benefits: according to the bill of amendment, the benefits will apply to the entire income of the competitive plant, and are not limited by time. This provided that the company meets the requirements set by the law during the relevant period. The law also stipulates an accelerated depreciation rate for productive assets used by the company. Furthermore, the said benefits are no longer contingent upon a minimal capital investment of the company, as is currently required.

Shareholders’ residence – under current law, the scope of benefits for companies is linked to the rate of foreign participation. Greater benefits apply to companies with a greater rate of foreign participation. According to the bill of amendment, the benefits granted by the law will apply to a company regardless of the tax residence of its shareholders. The benefits are strictly dependent upon the compatibility of the company (and its activity), with the requirements of the encouragement law.

Preservation of rights: Companies that are entitled to benefits under the current encouragement law will not be affected by the amendments; such is also the case with regards to companies that executed part of a minimal capital investment by the end of 2010.

In addition to the above said, within the economic policy for 2011-2012 discussions, it was recommended to enact tax incentives for investments in Israeli R&D companies that are at “seed stage”. Such investments bare high risks for investors. It is proposed to allow individuals investing in an Israeli R&D company to deduct their investment as an expense. Thus, provided that it was made until the end of tax year 2015 and in return the investor only received shares in the R&D Company. The expense can be deducted over 3 years beginning at the year of investment.

The expense can be recognized against any other income the individual has in Israel such as dividends, rent payment from an Israeli asset etc’. Similar incentives are proposed for such investments that will be made by Israeli companies by the end of 2015. The investment cost will be allowed as an expense spread over 5 years. Regretfully, the proposal does not include incentives for foreign companies investing in Israeli R&D companies. We can only wish the Israeli legislator will consider this issue as well.

With the aim of encouraging the Israeli Hi-Tech industry and innovative research and development in Israel, as well as the aim to attract highly qualified human resources to Israel, it is proposed to grant a tax exemption on royalty income paid to a “beneficiary resident”, for a period of 5 years.

According to the proposal, scientists or researches that are invited to Israel by an academic institution, or a hospital, to work for their R&D companies in Israel, may enjoy a tax exemption on their royalty income, paid to them by the R&D Company in Israel originating in export transactions).

The said exemption will only be granted to scientists or researches that will become “beneficiary residents”, or in other words, will become a veteran resident or a new immigrant (as defined in the Israeli Income Tax Ordinance) until the end of 2015. In addition, the beneficiary resident has to sign a contract with the Israeli R&D company within two years from the end of the tax year in which he arrived or returned to Israel. In any case, the entitlement for the benefit has to be approved by the Tax Authority inIsrael.

In this context, we may mention that a beneficiary resident who derives royalty income from sources outside of Israel can use an Israeli family company in order to enjoy a tax exemption on such income (for more information, see tax news alert No.6).

With the aim of encouraging the Israeli Hi-Tech industry and innovative research and development in Israel, as well as the aim to attract highly qualified human resources to Israel, it is proposed to grant a tax exemption on royalty income paid to a “beneficiary resident”, for a period of 5 years.

According to the proposal, scientists or researches that are invited to Israel by an academic institution, or a hospital, to work for their R&D companies in Israel, may enjoy a tax exemption on their royalty income, paid to them by the R&D Company in Israel originating in export transactions).

The said exemption will only be granted to scientists or researches that will become “beneficiary residents”, or in other words, will become a veteran resident or a new immigrant (as defined in the Israeli Income Tax Ordinance) until the end of 2015. In addition, the beneficiary resident has to sign a contract with the Israeli R&D company within two years from the end of the tax year in which he arrived or returned to Israel. In any case, the entitlement for the benefit has to be approved by the Tax Authority inIsrael.

In this context, we may mention that a beneficiary resident who derives royalty income from sources outside of Israel can use an Israeli family company in order to enjoy a tax exemption on such income (for more information, see tax news alert No.6).