Israel’s CFC Rules Clamp Down on Excessive Tax Planning

Bloomberg BNA’s Premier International Tax Library is a comprehensive global tax resource. Trust Bloomberg BNA's Premier International Tax Library for the guidance you need on...

By Jenny David

Nov. 29 — The Israel Tax Authority has issued a circular detailing its position on implementation of controlled foreign corporation rules to prevent excessive tax planning by Israeli corporations or individuals through ownership of foreign corporations in lower tax jurisdictions.

According to the circular, which relates to rules issued in 2013, Israeli corporations or shareholders owning more than 50 percent of a foreign company will be subject to Israeli taxes on their earnings from those companies.

Tax will also be applied to companies located in countries that impose less than 15 percent tax on corporate income. The threshold was reduced from 20 percent, following a drop in Israel’s corporate tax rate to 25 percent.

The circular also states that neither deemed dividends nor deemed credits will be recognized for Israeli tax purposes, only actual payments.

An ITA official attributed the CFC circular’s delay to the “regular procedures” allowing for public comment on the document, and its final adjustment.

The circular, published Nov. 17, relates to adjustments since the changes announced in 2013, along with details of definitions and processes through which the earlier changes will be implemented, the ITA official told Bloomberg BNA.

However, practitioners still voiced concern.

“The goal is correct, but the timing here seems strange,” one practitioner told Bloomberg BNA in a Nov. 28 interview.

“We’ve been acting on our own understanding of the reform for years, and now we get a document that looks at the details, but without considering the bigger picture,” he said, adding that the move “should consider the quality of foreign control, not just the quantity, since in many cases Israeli residents don’t really control the company and what it does.”

Other Main Changes

The tax authority stipulates that adjustments for corporate expenses will be recognized only when covered by a tax treaty between Israel and the host country. Companies in countries without tax treaties with Israel will need to report and pay according to Israeli tax codes, not financial reporting standards.

The circular also states that definitions of passive income and annual profit have been tightened to include, for example, Israeli taxation of any foreign securities portfolio managed through an Israeli company, whether or not it is taxable abroad. If the foreign portfolio was held for less than one year, the holder may petition the authority to waive the tax.

Further, to avoid classification as foreign-held, a company’s stock must be actively traded on the Tel Aviv Stock Exchange. Previously, it was sufficient for 30 percent of a company’s stock to be listed on the TASE, irrespective of whether the shares were actively traded.

Threshold Too High

Practitioners have also criticized the “narrow, bottom-line” approach of the circular.

Harel Perlmutter, head of the tax department at Tel Aviv-based Barnea & Co., called the 5 percent reduction in the foreign tax threshold “laughable.”

The rate “should have been reduced to 10-12 percent to keep Israel on par with other countries,” he told Bloomberg BNA in a Nov. 27 telephone interview.

Moreover, the ITA is “ignoring the way” some countries tax foreign-held companies by “looking only at the bottom line” instead of the “effective tax, after adjustments that can cause conflicts of interests between a company’s management and owners,” he said.

Another practitioner suggested that deemed taxes and credits “should be recognized reciprocally, rather than ruled out unilaterally.”

Overall, however, the reform is working, Perlmutter said, noting that “we have had to redirect clients toward holdings in countries below the 15 percent threshold, where they “may pay a bit more tax, but also avoid all these CFC problems.”

Release Linked to Critical Report

Israeli practitioners linked the CFC circular’s release—three years after the legislative reform—to a Nov. 1 report from Israel’s State Comptroller criticizing the ITA for failing to counter excessive tax planning. The critical report said the authority had cost the state billions in tax evasion by failing to close tax loopholes, adopt deterrent measures or pursue and punish violators of existing legislation. Neither could it provide information on the proportion of taxpayers evading reporting through aggressive tax planning, the report noted.

“It appears that, in many cases, the current tax regime and the level of enforcement in all matters pertaining to taxing income from overseas makes it possible to evade paying taxes not only through tax planning and the use of tax shelters, but simply by not reporting income, in the knowledge that the chances that the Tax Authority will trace the tax evader are not good,” State Comptroller Yosef Shapira wrote.

Although it took issue with the comptroller’s report, the ITA did issue a long-awaited circular closing a foreign income exemption loophole, as well as a ruling on taxation of income from international financial services, soon after it received the draft report.

To contact the reporter on this story: Jenny David in Jerusalem at psukhraj@bna.com

To contact the editor responsible for this story: Penny Sukhraj at psukhraj@bna.com

Copyright © 2016 The Bureau of National Affairs, Inc. All Rights Reserved.