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Israeli Tax Law Firm

Wind of change
The Israel Committee for International Tax Reform has released its report

We have recently seen major advancements in technology in all its aspects. New companies and new partnerships are continually being formed to meet the needs of a world hungry for new and revolutionary technologies. Whether it's aservice, a commodity, or information, anyone, or any business in almost any location can now take advantage of technological abundance and free - exchange. Unfortunately, with the development of international business and economic models, enforcement problems have arisen due to aggressive tax planning which has exploited every potential tax loophole. In view of these difficulties as well as the changes in international tax policy as a result of the BEPS project and the ATAD's European anti-tax evasion regulation. the necessity arises to re-examine Israeli law rule sconcerning international taxation. In relation to this matter, the Director of the Israeli Tax Authority, Mr. Eran Yaakov, has formed a committee whose task is to propose the necessary changes to the Israeli tax laws in the field of international taxation. the committee conducted extensive legal and tax studies before submitting its proposals in November 2021.

We're going to focus on four of the committee suggestions in this article: Determining the tax residency of individuals, Exit tax, LLC companies and Anti-hybrid rules.

A: Determining the tax residency of individuals
According to current legislation, an individual is considered a resident of Israel (for tax purposes) if their center of life is in Israel. The center of an individual's life is determined by all their family, economic and social relationships. Since the center of life test is difficult to apply, in the current law, there is a rebuttable presumption that an individual is considered a resident of Israel for tax purposes in one of two circumstances.

  • Anyone who spends 183 days or more in Israel duringa tax year is considered a resident of Israel for tax purposes.
  • Anyonewho has resided in Israel for at least 30 days during a tax year and has resided in Israel for a total of 425 days or more in that tax year and the last two taxyears (combined) are Israeli residents for tax purposes.

The current legislation leads to numerous discussions between the Israeli tax authorities and taxpayers about the "center of life" and consequently the degree of certainty about the tax residence of the individual is quite low. Therefore, the committee recommends the following presumptions, in the presence of which it will be indisputably determined that the individual is a tax resident of Israel.

  • An individual who resides in Israel for two consecutive tax years of 183 days ormore in each tax year is deemed to be an Israeli resident from the first tax year of his residency.
  • An individual who resided in Israel for 100 days or more during the tax year, and if his stay in the tax year and the previous two years (hereinafter: "Review of the tax years") is 450 days or more, will be considered as an Israeli resident for tax purposes during the tax year.

    The existence of this presumption will not lead to the determination of residency in Israel if the individual has resided, for 183 days or more in all the tax years examined in a state that is a signatory to the Convention on the Prevention of Double Taxation on Income. (Hereinafter: "the State of the Convention"), and he invented a certificate of residency for tax purposes from that Contracting State.
  • The individual spent 100 days or more in Israel during the tax year and their spouse or the person managing their shared home is an Israeli resident.

It should be noted that the committee also recommends six presumptions, the existence of which would provide permanent evidence that the individual is a tax resident in another country. In addition to the absolute presumption that a person would be classified as a resident of Israel or a foreign resident depending on the circumstances of the case, the committee recommended continuing to rely on the life center test including the quantitative test, as a rebuttable presumption, for the purpose of determining the place of residence of an individual, When the absolute presumption is not applicable.

B: Section 100A of the Income Tax Ordinance - "Exit tax"
The goal of Section 100A of the Income Tax Ordinance is to address those situations where a former Israeli resident sold the property after becoming a foreign resident in a way that denies Israel the ability to tax the value of the property while the seller was resident in Israel. This clause (known as "Exit Tax") gives the State of Israel the power to tax the proportional increase in property value. The central assumption of the sectionis the preservation of the tax continuity of the State of Israel. The committee's report recommends major revisions to Section 100A of the Income Tax Ordinance, largely aimed at ensuring the Israeli tax authority's ability to collect the tax effectively.

Like existing legislation, taxpayers who have ceased to reside in Israel will have the option to pay the exit tax immediately or defer payment to a later date. However, the Committee recommends that both options have more stringent reporting requirements and that the income tax assessor be empowered to request specific insurance to ensure future tax payment.

Selected recommendations and clarifications that apply to all tracks:

  • The terms of the exit tax method chosen by the taxpayer apply to all their exittaxable assets (unless expressly stated otherwise).
  • Profits accrued in an Israeli legal entity (due to control and management and if it was not formed in Israel) shall be taxed on departure tax at the time of severance of residence - without the possibility of deferring tax payment.
  • The inclusion of a clause in the law that states that the provisions of Section 97 (b3) of the Income Tax Ordinance do not apply to assets covered by Section 100A of the Income Tax Ordinance. This clause does not enable the legal entity to claim the exemption afforded by section 97 (b3) on Israeli assets acquired while he is a resident of Israel.
  • Section 100A of the Income Tax Ordinance applies to an individualor corporation resident in Israel for tax purposes, or a permanent establishment in Israel of a foreign resident transferring an intangible asset to the individual or company's head office or another permanent establishment. Given the foregoing, and in order to avoid aggressive tax planning and tax evasion, the Committee recommends that payment of exit tax on intangible assets will not be deferred until the date of realization of the intangible asset, regardless of the method chosen by the taxpayer. Furthermore, the above shall apply in the situation of a company resident in Israel by virtue of control and management or in the case of an individual resident in Israel who has intangible assets held by him, who have ceased to be residentsof Israel.

C: LLC Companies
One of the most serious tax inefficiencies in international taxes is caused by the differential treatment of LLCs under the US and Israeli law. While in the United States LLCs are declared "transparent" by default and income and losses are credited to LLC members, the Israeli tax system regards these companies as separate legal entities subject to corporation tax. LLC entities through ITA circulars stating that the LLC's income may only be allocated to its members for over seas tax credit purposes. Despite the relief, the ITA has consistently refused to recognize the LLC as a truly transparent company, meaning that losses from one company cannot be offset by profits from another. This stance has created several distortionsand exposed taxpayers to double taxation on U.S. investments.

While the Committee believes that it is not necessary to regulate LLC's statuses under Israeli law, it recommends amending Income Tax Circular 5/2004 so that LLC losses in the year following the amendment can be offset against the income of the individual or company resident in Israel exclusively from sources andassets in the United States LLCs, partnerships, and other S corporation owned by the individual or corporation and that the loss is effectively required in the United States. And this is subject to the conditions and restrictions set out in the Income Tax Ordinance, in particular Article 29. It should be noted that the decision on the application of the circular (like the previoussituation) will be made in the first year of submitting the report and it is irreversible.

D: Hybrid mismatch - or, in other words, anti-hybrid regulations
BEPS[1] -Action 2 Neutralising the effects of hybrid mismatch arrangements:
Hybrid mismatch arrangements are used in aggressive tax planning to exploit differences in the tax treatment of an entity or instrument under the laws of two or more tax jurisdictions to achieve double non-taxation, including long-term taxation deferral.

These types of hybrid mismatch arrangements were widespread and resulted in a substantial erosion of the taxable bases of the jurisdictions concerned. These risks were highlighted in the context of international banking in the 2010 OECD report Addressing Tax Risks Involving Bank Losses and a subsequent review by various OECD member countries identified examples of tax planning using hybrid mismatch arrangements which led to the 2012 OECD report Hybrid Mismatch Arrangements: Tax Policy and Compliance issues. The 2012 report identified that hybrid mismatch arrangements, in addition totheir impact on tax revenues, also have an overall negative impact on competition, efficiency, transparency and fairness. [2].

The committee recommends the implementation of BEPS Action 2. In general, this is a denial of incomededuction or credit when taxpayers enter into hybrid agreements to reduce their tax liability in Israel.

The anti-hybrid rules' guiding principles:

  • The proposed limits will apply to aggregate transactions of more than 500,000 NIS per year.
  • Adoption of a large part of the proposals and definitions in Action 2 be accepted in the scope of Israeli domestic legislation, under section 86A of the Income TaxOrdinance.
  • If the recipient is an Israeli resident and the payer's country has not applied this recommendation, the Israeli resident should be attributed with an income in Israel equal to the expenses permitted abroad.

Before finishing this chapter, it is important to note that these are exceedingly detailed and complex provisions, and the information provided above is merely a synopsis.

[1]The BEPS project was launched by the G20 Forum and the OECD, which led to the development of 15 lines of action to combat international tax planning, which aim at base erosion and profit shifting.