Tax treaty amendments
In 2018, the country’s 56 tax treaties may be amended in one go after signing on June 7 the OECD multilateral instrument to implement tax treaty-related measures to prevent base erosion and profit shifting. BEPS is the OECD program aimed at preventing offshore tax planning by multinational groups. Many other countries are doing the same.
But it takes two to tango. The treaties will be amended if the treaty partners follow suit. Subject to this, we review below the anticipated changes to the country’s tax treaties. These changes are expected to take effect in 2018 according to Israeli tax officials. A formal announcement to this effect is anticipated.
Dividends, real estate capital gains:
Israel intends to amend 36 treaties (not with the US or UK) to allow reduced tax rates for dividends only if relevant ownership conditions are met throughout a 365-day period including the dividend payment date.
Israel intends to amend all its treaties to allow tax in a country upon a sale of an interest in a company, partnership or trust that derived more than 50% of their value from real estate in that country at any time during the 365 days preceding the sale.
Tax planning by multinationals and the digital economy have taken a huge toll on governmental tax revenues in recent years. One technique was to allocate profits to the cloud, which is nowhere for tax purposes.
So the concept of a PE – a taxable fixed place of business or a “dependent agent” – will be tightened in all Israel’s treaties.
A taxable dependent agent would now be a person in a country who: (1) habitually concludes contracts (2) or plays the principal role leading to the conclusion of contracts routinely without material modification; and these contracts are: (a) in the name of a foreign enterprise, or (b) for the transfer of ownership or right to use property owned or used by the foreign enterprise, (c) for the provision of services by the foreign enterprise.
Furthermore, a related company (over 50% control in terms of votes or value of shares by one party over the other, or common control) acting exclusively or almost exclusively for the group would now be considered a dependent agent.
Moreover, Israel joins a chorus of other countries that will now treat warehouses as a PE. They will no longer be considered preparatory or auxiliary. These rules complicate e-commerce for large and small operators, and may spell the death sentence for international agency arrangements.
Treaty denial for residents?
Controversially, when taxing residents, Israel reserves the right to deny numerous treaty benefits, regarding: foreign tax credits, correlative or corresponding adjustment following an initial adjustment by another treaty country (but see below), services rendered to a foreign government, students researchers and professors, discriminatory taxation, competent authority appeals, pension and alimony taxation abroad only and other treaty exemptions. That doesn’t leave much.
For example, if the US Internal Revenue Service claims an Israeli online operator has a taxable US permanent establishment and the Israel Tax Authority disagrees, the Tax Authority may refuse to give a foreign tax credit, resulting in double taxation. The US may play fair, some other countries may not, resulting in uncertainty which treaties are affected.
Under a separate clause, if another country makes a transfer pricing adjustment to the profits of an Israeli resident enterprise, Israel intends to grant a corresponding adjustment under all its treaties to the amount of tax charged, but “due regard” will be had to other treaty provisions and the competent tax authorities shall if necessary consult each other. Comment: This may drag on...
The OECD wants to make it possible for taxpayers to lodge treaty appeals to the competent tax authority of either country involved. Israel reserves the right under all its treaties to insist on treaty appeals being made to the home country tax authority. Israel is not joining a mandatory mediation procedure.
This refers to US LLCs Israeli family companies and other companies where the shareholder is taxed, not the company. Income would be considered to be derived by a resident of a treaty country if the income is taxed as income of a resident there.
Dual resident entities:
Israel intends to amend all its treaties to say that dual-resident entities will be considered resident where its place of effective management is. This would improve things under the Israel-US treaty if the US follows suit. (It probably won’t.)
Israel intends to amend all its treaties to say that their purpose is to eliminate double tax without creating opportunities. Israel intends to tighten up 15 of its treaties (including those with Germany, India, Ireland, Malta, Panama and Russia) to deny a treaty benefit if it is reasonable to conclude that obtaining the benefit was one of the principal purposes of any arrangement or transaction – unless this was in accordance with the purpose of the relevant provisions in the treaty.
As always, consult experienced tax advisers in each country at an early stage in specific cases.
Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.