International Tax and Transaction Services – Transfer Pricing
Eyal Gonen
Tsippy Herbst
Dana Erell
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International Tax and Transaction Services – Transaction Tax Advisory
Nir Zarug
Ziv Manor
Hagai Oppenheim
People Advisory Services
Korine Hagit,
Global Mobility
Dikla Reznik,
Stock-Based Compensation
Indirect Tax
Avi Bibi
Regev Itzhaki
Keren Israeli-Arviv
Dana Halifi
Real Estate
Vered Olpiner-Sakel
Eli Farjon
Tax Controversy
Kfir Nahum
Haifa
Ernst & Young (Israel) Ltd
Kost Forer Gabbay & Kasierer
Brosh Building, 2 Pal-Yam Avenue
Haifa 3309502
Israel
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salaries for a period of two and one-half to four years, depending on the location, number of employees and the employees’ salaries.
On 15 November 2021, Israel released its 2021-2022 Budget Law (Budget Law), which introduced a new dividend distribution ordering rule to cause the distribution of earnings that were tax exempt under the historical Approved or Beneficial Enterprise regimes (Trapped Earnings) to be on a pro rata basis from any dividend distribution. The new rule applies to distributions from 15 August 2021 onward. This means that the corporate income tax clawback will apply on any dividend distribution, as long as the company has Trapped Earnings.
In parallel, the Budget Law also includes a Temporary Order to enhance the release of Trapped Earnings by reducing the clawback corporate income tax rate that is applicable on such a release or distribution by up to 60%, but not less than a 6% corporate income tax rate, during a one-year period that ended on 15 November 2022.
Innovation box. Israel approved an innovation box regime for intellectual property (IP)-based companies, effective from 1 January 2017. This regime is included in the Encouragement of Capital Investments Law.
The Israeli government tailored this regime to the Organisation for Economic Co-operation and Development (OECD) Base Erosion and Profit Shifting (BEPS) framework, encouraging multinationals to consolidate IP ownership and profits in Israel, together with existing Israeli research and development (R&D) functions.
Tax benefits created to achieve this goal include a reduced corporate income tax rate of 6% on IP-based income and on capital gains from future sales of IP. The 6% rate applies to qualifying Israeli companies that are part of a group with global consolidated revenue of over ILS10 billion (approximately USD2.9 billion).
Other qualifying companies with global consolidated revenue below ILS10 billion are subject to a 12% tax rate. However, if the Israeli company is located in a development area, the tax rate is further reduced to 7.5%.
In addition, a 20% withholding tax should be applied on dividends distributed out of income that was subject to the tax incentives (unless further reduced by a treaty). Furthermore, a 4% dividend withholding tax may be applied for the taxable preferred technology income if at least 90% of the company’s shares are held directly by one or more foreign companies.
Entering into the regime is not conditioned on making additional investments in Israel. A company can qualify if it invests at least 7% of the last three years’ revenue in R&D (or incurs ILS75 million in R&D expenses per year) and if it meets one of the following conditions:
• It has at least 20% R&D employees (or more than 200 R&D employees).
• A venture capital investment of ILS8 million was previously made in the company.
Capital losses may be used to offset capital gains derived in the same or future tax years without time limit. In each year, capital losses are first offset against real gains and then offset against taxable inflationary amounts in accordance with the following ratio: ILS3.5 of inflationary amounts per ILS1 of capital losses. Capital losses from assets located abroad must be offset against capital gains on other assets abroad, then against capital gains from assets in Israel.
Capital losses incurred on securities can also be offset against dividend and interest income in the same year, subject to certain conditions.
Nonresidents. Unless a tax treaty provides otherwise, in principle, nonresident companies and individuals are subject to Israeli tax on their capital gains relating to any of the following:
• An asset located in Israel.
• An asset located abroad that is primarily a direct or indirect right to an asset, inventory or real estate in Israel or to a real estate association (an entity whose primary assets relate to Israeli real estate). Tax is imposed on the portion of the consideration that relates to such property in Israel.
• Shares or rights to shares (for example, warrants and options) in an Israeli resident entity.
• A right to a nonresident entity that primarily represents a direct or indirect right to property in Israel. Tax is imposed on the portion of the consideration that relates to such property in Israel.
Foreign residents not engaged in business in Israel may qualify for exemption from capital gains tax on disposals of the following investments:
• Securities traded on the Tel-Aviv stock exchange (with certain exceptions)
• Securities of Israeli companies traded on a recognized foreign stock exchange
The above exemption does not apply to the following:
• Gains attributable to a permanent establishment (generally a fixed place of business) of the investor in Israel
• Shares of Real Estate Investment Trust (REIT) companies
• Capital gains derived from the sale of Israeli governmental short-term bonds (issued for 13 months or less)
Foreign residents may also qualify for an exemption from capital gains tax on disposals of all types of Israeli securities not listed to trade that were purchased on or after 1 January 2009 if the seller (the company or individual who sold the Israeli securities to the foreign resident) was not a related party.
The above exemption does not apply to the following:
• Gains attributable to a permanent establishment (generally a fixed place of business) of the investor in Israel
• Shares of a company whose assets are principally Israeli real estate
• Shares of a company that has the value of its assets derived principally from the usufruct of immovable property and right to payments as consideration for the working of, or the right to work, mineral deposits, sources and other natural resources (for example, companies that hold licenses to exploit gas and minerals in Israel’s territory, which includes Israel’s economic water)
With respect to foreign dividend income, an Israeli company may receive a direct and an underlying tax credit for foreign taxes. The foreign dividend income is grossed up for tax purposes by the amount of the creditable taxes. The following are the alternative forms of the credit:
• Direct foreign tax credit only: corporate tax rate of 23% is imposed on foreign dividend income, and any dividend withholding tax incurred is creditable in Israel.
• Direct and underlying foreign tax credit: corporate tax rate of 23% is imposed on foreign dividend income, and a credit is granted for dividend withholding tax and underlying corporate tax paid abroad by 25%-or-greater affiliates and their direct 50%-or-greater subsidiaries. If an underlying foreign tax credit is claimed, any excess foreign tax credit may not be used to offset company tax in future years.
C. Determination of trading income
General. Taxable income is based on financial statements that are prepared in accordance with generally accepted accounting principles and are derived from acceptable accounting records. In principle, expenses are deductible if they are wholly and exclusively incurred in the production of taxable income. Various items may require adjustment for tax purposes, including depreciation, R&D expenses, and vehicle and travel expenses.
Inventories. In general, inventory may be valued at the lower of cost or market value. Cost may be determined using one of the following methods:
• Actual
• Average
• First-in, first-out (FIFO)
The last-in, first-out (LIFO) method is not allowed.
Provisions. Bad debts are deductible in the year they become irrecoverable. Special rules apply to employee-related provisions, such as severance pay, vacation pay, recreation pay and sick pay.
Depreciation. Depreciation at prescribed rates, based on the type of asset and the number of shifts the asset is used, may be claimed with respect to fixed assets used in the production of taxable income.
Accelerated depreciation may be claimed in certain instances. For example, under the Inflationary Adjustments Regulations (Accelerated Depreciation), for assets first used in Israel between 1 June 1989 and 31 December 2016, industrial enterprises may depreciate equipment using the straight-line method at annual rates ranging from 15% to 22%. Alternatively, they may depreciate equipment using the declining-balance method at rates ranging from 20% to 30%.
The following are some of the standard straight-line rates that apply primarily to non-industrial companies.
(a) Subject to the fulfillment of certain conditions.
(b) For industrial companies, subject to the fulfillment of certain conditions.
Groups of companies. Subject to certain conditions, consolidated returns are permissible for an Israeli holding company and its Israeli industrial subsidiaries if the subsidiaries are all engaged in the same line of production. For this purpose, a holding company is a company that has invested at least 80% of its fixed assets in the industrial subsidiaries and controls at least 50% (or two-thirds in certain cases) of various rights in those subsidiaries. For a diversified operation, a holding company may file a consolidated return with the subsidiaries that share the common line of production in which the largest amount has been invested.
Group returns may also be filed by an Israeli industrial company and Israeli industrial subsidiary companies if the subsidiaries are at least two-thirds controlled (in terms of voting power and appointment of directors) by the industrial company and if the industrial company and the subsidiaries are in the same line of production.
Detailed rules concerning the deferral of capital gains tax apply to certain types of reorganizations, including corporate mergers, divisions and shares-for-assets exchanges. In many cases, an advance ruling is necessary.
Relief for losses. In general, business losses may be offset against income from any source in the same year. Unrelieved business losses may be carried forward for an unlimited number of years to offset business income, capital gains derived from business activities or business-related gains subject to the Land Appreciation Tax (see Section B). According to case law, the offset of losses may be disallowed after a change of ownership and activity of a company, except in certain bona fide circumstances.
Special rules govern the offset of foreign losses incurred by Israeli residents. Passive foreign losses may be offset against current or future foreign passive income (for example, income from dividends, interest, rent or royalties). Passive foreign rental losses arising from depreciation may also be offset against capital gains from the sale of the relevant foreign real property.
Active foreign losses (relating to a business or profession) may be offset against the following:
• Active foreign income and business-related capital gains in the current year.
• Passive foreign income in the current year.
• Active Israeli income in the current year if the taxpayer so elects and if the foreign business is controlled and managed in Israel. However, in the preceding two years and in the following five years, foreign-source income is taxable up to the amount of the foreign loss.
• Active foreign income and business-related capital gains in future years.
D. Other significant taxes
The following table summarizes other significant taxes.
Nature of tax
Value-added tax (VAT), standard rate 17
Wage and profit tax, imposed on financial institutions instead of VAT; this tax is imposed in addition to company tax 17
National insurance contributions on monthly employment income (subject to an upper income limit that fluctuates periodically)
Employer payments; rates depend on residency of employee Various Employee payments; rates depend on residency of employee
Payroll levy on salaries of foreign employees; levy does not apply if monthly salary exceeds twice the average monthly salary
Acquisition tax, imposed on purchasers of real estate rights; maximum rate
Various
10 to 20
0 to 10
Annual municipal taxes on property Various
E. Miscellaneous matters
Foreign-exchange controls. The Israeli currency is the new Israel shekel (ILS).
No exchange-control restrictions exist.
Debt-to-equity rules. No thin-capitalization rules are imposed in Israel.
Transfer pricing. Transactions between related parties should be at arm’s length. Detailed transfer-pricing regulations apply. An Israeli taxpayer must report on each international transaction undertaken with a related party and indicate the arm’s-length amount for such transaction as well as the chosen method. In addition, on 22 September 2022, an amendment to the Israeli transfer-pricing regulations was published following the adoption of the BEPS Action 13 principles in domestic legislation (Local File, Master File, and Country-by-Country Reporting). Most of the new regulations, which require substantial preparation, apply to the 2022 fiscal year; however, part of the regulations (especially those that apply to an Israeli Ultimate Parent Entity that heads a multinational enterprise group with revenue of more than ILS3.4 billion [approximately USD970 million]), are applicable to the 2021 fiscal year. Advance rulings may be requested regarding transfer pricing.
Measures to counteract tax planning involving foreign companies.
Certain measures are designed to counteract tax planning involving foreign companies.
Foreign professional companies. Israeli residents are taxed on deemed dividends received from foreign professional companies (FPCs) at the standard corporate tax rate; a foreign corporate tax credit is available. In addition, on the actual distribution of dividends by FPCs, Israeli residents are subject to dividend tax. A
company is considered to be an FPC if a company meets all of the following conditions:
• It has five or fewer ultimate individual shareholders.
• It is owned 75% or more by Israeli residents.
• Most of its 10%-or-more shareholders conduct a special profession for the company.
• Most of its income or profits are derived from a special profession.
The special professions include engineering, management, technical advice, financial advice, agency, law, medicine and many others.
Controlled foreign corporations. Israeli residents are taxed on deemed dividends received from a controlled foreign corporation (CFC) if they hold 10% or more of the CFC. A foreign company (or any other body of persons) is considered to be a CFC if all of the following conditions exist:
• The foreign company primarily derives passive income or profits that are taxed abroad at a rate of 15% or less.
• The foreign company’s shares are not publicly traded, or less than 30% of its shares or other rights have been issued to the public or listed for trade.
• One of the following requirements is satisfied:
— Israeli residents own either directly or indirectly more than 50% of the foreign company.
— An Israeli resident owns over 40% of the foreign company, and together with a relative, owns more than 50% of the company.
— An Israeli resident has veto rights with respect to material management decisions, including decisions regarding the distribution of dividends or liquidation.
The shareholdings of the CFC are calculated as the higher of the following:
• The shareholdings at the tax year-end
• The shareholdings any day in the tax year plus any day in the following tax year
The deemed dividend is the taxpayer’s share of passive undistributed income on the last day of the tax year.
Reportable transactions. Certain types of transactions with foreign companies must be reported to the tax authorities.
Withholding taxes on overseas remittances. Israeli banks must withhold tax, generally at a rate of 23%, from most overseas remittances unless the remittances relate to imported goods. An exemption or a reduced withholding rate may be obtained from the Israeli tax authorities in certain circumstances, such as when a treaty applies or when the payments are for services that are rendered entirely abroad. A 30% withholding tax rate applies to dividends paid to recipients holding 10% or more of the payer entity.
Free-trade agreements. Israel has entered into free-trade agreements with Canada, Colombia, the European Free Trade Association, the European Union, Guatemala, Jordan, Korea (South), Mexico, Panama, the Southern Common Market (Mercado Común del Sur, or MERCOSUR) countries, Türkiye, Ukraine, the United Arab Emirates, the United Kingdom and the United States.
(s) The 10% rate applies if the recipient holds at least 10% of the capital of the payer.
(t) The 15% rate applies unless a lesser rate may be imposed by the Philippines on royalties derived by a resident of a third country in similar circumstances. The Philippines-Germany treaty specifies a 10% withholding tax rate on industrial and commercial royalties. Consequently, a 10% rate might apply to these royalties under the Israel-Philippines treaty.
(u) The 5% rate applies to royalties for the use of industrial, commercial or scientific equipment. The 7.5% rate (Vietnam) applies to technical fees.
(v) The 5% rate applies to interest on bank loans as well as to interest in connection with sales on credit of merchandise between enterprises or sales of industrial, commercial or scientific equipment. Interest on certain government loans is exempt.
(w) Under a disputed interpretation of the treaty, a 15% rate may apply to dividends paid out of the profits of an approved enterprise or property.
(x) The tax rate on the royalties in the recipient’s country is limited to 20%.
(y) The 2% rate applies to interest paid on certain government loans. The 5% rate applies to interest received by financial institutions that grant loans in the course of its usual business activities. The 10% rate applies to other interest payments.
(z) This rate applies to interest in connection with sales on credit of merchandise between enterprises and sales of industrial, commercial or scientific equipment, and to interest on loans granted by financial institutions.
(aa) The 5% rate applies to royalties paid for the use of industrial, commercial or scientific equipment (and road transport vehicles under the Belarus treaty), or for copyrights of literary, dramatic, musical or artistic works. The rate for other royalties is 10% (Belarus) or 7% (Spain).
(bb) The 10% rate applies if the recipient is an Israeli resident or if the recipient is a Thai resident holding at least 15% of the capital of the payer.
(cc) The 10% rate applies to interest paid to banks or financial institutions, including insurance companies.
(dd) The 5% rate applies to royalties paid for the use of literary, artistic or scientific works, excluding radio or television broadcasting works.
(ee) Interest on certain government loans is exempt (under the Azerbaijan treaty, interest paid to the State Oil Fund is also included). The 10% rate applies to all other interest payments.
(ff) The 12.5% rate applies to dividends paid by a company that does not have an approved enterprise or approved property in Israel to US corporations that own at least 10% of the voting shares of the payer, subject to certain conditions. The 15% rate applies to dividends paid out of the profits of an approved enterprise or property. The 25% rate applies to other dividends.
(gg) The 10% rate applies to interest on a loan from a bank, savings institution, insurance company or similar company. The 17.5% rate applies to other interest. Alternatively, an interest recipient may elect to pay regular tax (the company tax rate is currently 26.5%) on the lending profit margin.
(hh) The 10% rate applies to copyright and film royalties. The 15% rate applies to industrial and other royalties.
(ii) The 5% rate applies to royalties paid for the use of literary, artistic or scientific works, excluding cinematographic films. The 10% rate applies to other royalties.
(jj) The 15% rate applies to royalties for the use of, or the right to use, trademarks. The 10% rate applies to other royalties.
(kk) The 5% rate applies if the dividends are paid to a corporation holding at least 25% of the payer’s capital. The 10% (Canada, 15%) rate applies to other dividends.
(ll) The 0% rate applies to interest with respect to sales on credit of merchandise or industrial, commercial or scientific equipment. Under the Lithuania treaty, such credit must not exceed six months and related parties are excluded.
(mm) The 0% rate applies to interest with respect to a loan, debt-claim or credit guaranteed or insured by an institution for insurance or financing of international trade transactions that is wholly owned by the other contracting state (Denmark, Georgia and Moldova) or acts on behalf of the other contracting state (Slovenia), and with respect to interest paid on traded corporate bonds (Denmark and Georgia). The 5% rate applies to other interest.
(nn) See Sections A and B. A 25% withholding tax rate applies to dividends and other payments to recipients who hold under 10% of the payer entity.
(oo) The 0% rate applies if the recipient is a company that holds directly at least 10% of the capital of the payer for a consecutive period of at least 12 months.