Israel Tax Treaty

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United States-Israel Tax Treaty

Israel International Tax Compliance Rules

Quick Summary.

U.S.-Israel Tax Treaty

Israel Tax Treaty

Currency. New Israeli Shekel (NIS)

Common Legal Entities.  

Public and private limited liability company

           Partnership (registered and unregistered)

           Branch of a foreign company

Tax Authorities. Ministry of Finance, Israel Tax Authority

Tax Treaties.   Ireland is party to more than 60 treaties and is a signatory to the OECD multilateral instrument (MLI).

Corporate Income Tax Rate.  

23% standard.

Israeli company classified as preferred enterprise is taxed depending on where its facilities are located.

Classified as approved or a benefited enterprise – rate between 0% and 23%

Classified as preferred technological enterprise – reduced rate of 12%

Individual Tax Rate. 

Up to NIS 74,640 – 10%

NIS 74,641 to 107,040 – 14%

NIS 107,041 to 171,840 – 20%

NIS 171,842 to 238,800 – 31%

NIS 238,801 to 496,920 – 35%

NIS 496, 921 to 640,000 – 47%

Exceeding NIS 640,000 – 47% plus 3% surtax

Corporate Capital Gains Tax Rate. 

Depends on purchase date and nature of assets. Standard rate 23%

          Sale of shares – tax exempt in certain circumstances

          Not residents – exempt

Derived from the sale of securities in Israel or Israeli-related companies acquired on or after 1 Jan. 2009.

Derived by a preferred technological enterprise or special technological enterprise sale of qualifying intangible assets to related nonresident company – 12% or 6% depending

Individual Capital Gains Tax Rate. 

Derived from sale of shares – 25%, if derived by non-controlling shareholders, otherwise 30%

Sale of bonds, commercial securities – 20%

All other assets range from 20% up to individual marginal tax rate

Residence.  

Individual.  An individual is deemed a tax residence if his/her “center of vital interests” is in Israel. Residence is assumed if an individual is present for 183 days or more in Israel or if during the tax year the individual spends 30 days or more and presence in the total of preceding two tax years total to 425 days or more.

Corporate.  Corporate residence is based on the location of activities are management and control or incorporated under the laws of Israel

Withholding Tax.

            Dividends. 

                     Corporate Resident – 0%; 15%; 20% and nonresident 4%; 15%; 20%; 25%;30%

 Individual Resident and nonresident – 15%; 20%; 25%; 30%

            Interest. 

Corporate Resident – 23% and nonresident 0%; 23%

                     Individual Resident – 15%; 20%; 25%; 35%; 47%  and nonresident – 0%; 25%

            Royalties. 

                     Corporate Resident – 20%; 30% and nonresident 23%

Individual Resident – 20%; 30% and nonresident – 25%

            Commissions. 

                     Corporate Resident – 20%; 30% and nonresident 23%

Individual Resident – 20%; 30% and nonresident – 25%

Transfer Pricing.  

Israeli transfer pricing rules are based on OECD guidelines and apply to transactions between an Israeli resident and related nonresident.

CFC Rules. 

Controlled by Israeli shareholders and that has accumulated undistributed passive profits at a lower tax rate than 15%.

Hybrid Treatment. 

Provisions in Israeli tax ordinance allow for re-characterization or tax authorities to disregard a transaction if tax avoidance is the main purpose of the transaction.

Inheritance/estate tax. No

Set forth below are explanations, analysis, and insights with respect to the Convention between the United States and Israel, signed on November 20, 1975, as amended by a Protocol signed on May 30, 1980, (“the Convention”).

Taxes Covered

With respect to the United States, the Convention covers the Federal income taxes imposed by the Internal Revenue Code (“Code”). The Convention also applies to the excise tax on insurance premiums paid to foreign insurers, under section 4371 of the Code. However, the excise tax on insurance premiums is covered only to the extent that the foreign insurer does not reinsure the risks, directly or indirectly, with a person who is not entitled to exemption from such tax under the Convention or another tax convention. This limitation on coverage clarifies that persons not entitled to the benefits of this or another convention are not entitled to use an insurer in Israel as a conduit for the purpose of obtaining convention benefits. The Convention also provides for certain rights with respect to the United States to impose taxes under Code sections 531 (accumulated earnings tax) and 541 (personal holding company tax).

The Convention does not include coverage of the estate, gift and generation-skipping transfer taxes, Federal unemployment taxes and social security taxes imposed under sections 1401 , 3101 and 3111 of the Code.

In the case of Israel, the Convention applies to the income tax (including capital gains tax); the company tax; the tax on gains from the sale of land under the land appreciation tax law; the tax on profits levied on banking institutions and insurance companies under the Value Added Tax Law. 

The Convention also applies to taxes substantially similar to such taxes that are imposed in addition to, or in place of, existing income taxes.

Fiscal Residence

The Convention provides rules for determining the residence of individuals, corporations, and other persons. Generally, only a resident of one of the Contracting States may qualify for the benefits of the Convention. A person who, under the respective taxation laws of the Contracting States, is a resident of one Contracting State and not the other need look no further to determine his residence under the Convention. However, where a person is a resident of each of the Contracting States under its laws, the Convention provides rules to determine that person’s residence for purposes of the Convention. 

The term “resident of Israel” means an Israeli corporation or any other person (except a corporation or any entity treated under Israeli law as a corporation) resident in Israel for purposes of Israeli tax. Similarly, “resident of the United States” means a United States corporation and any other person (except a corporation or any entity treated as a corporation for United States tax purposes) resident in the United States for purposes of United States tax. Thus, a resident of the United States includes a resident alien individual, an alien present in the United States who elects to be treated as a resident under Code section 6013(g) or (h), and a resident citizen, but under no circumstances, a foreign corporation. A citizen of the United States or Israel is not automatically a resident of the United States or Israel for purposes of this Convention. Whether a citizen of the United States is a resident of the United States for this purpose is to be determined by the principles of the Treasury regulations issued under Code section 871.

The Convention provides that a partnership, estate, or trust is a resident of a Contracting State only to the extent that the income derived by such person is subject to tax in such Contracting State as the income of a resident. For example, under United States law, a partnership is never, and an estate or trust is often not, taxed as such. Under the Convention, in the case of the United States, income received by a partnership, estate, or trust will not qualify for the benefits of the Convention unless such income is subject to tax in the United States as the income of a resident. Thus, in effect, the treatment of income received by a partnership will be determined by the residence and taxation of its partners with respect to that income. To the extent the partners are subject to United States tax as residents of the United States, the partnership will be treated as a resident of the United States. Similarly, the treatment of income received by a trust or estate will be determined by the residence and taxation of the person subject to tax on such income, which may be the grantor, the beneficiaries or the trust of estate itself, as the case may be.

The Convention provides that an individual who is a resident of both Contracting States will be deemed to be a resident of the Contracting State in which he has his permanent home, his center of vital interests (closest personal and economic relations), a habitual abode, or his citizenship, in the order listed. In the case of an individual who is an “oleh” under section 9(16) of the Israeli Income Tax Ordinance, his center of vital interests will be deemed to be in Israel. If the issue is not settled by these tests, the competent authorities will decide by mutual agreement the one Contracting State of which he will be considered to be a resident.

The Convention provides that a corporation which qualifies both as a resident of the United States and as a resident of Israel will be considered to be outside the scope of the Convention, except for purposes of paragraph (1) of Article 4 (Source of Income), Article 27 (Nondiscrimination), Article 29 (Exchange of Information), and Article 31 (Entry into Force). 

Dual resident corporations are given the benefits of the nondiscrimination provisions, and the competent authorities are given the authority to exchange information with respect to such corporations. The exception for Article 4(1) permits the United States to tax dividends paid to an Israeli resident by a corporation which is incorporated in the United States and is managed and controlled in Israel. 

Permanent Establishment

The existence of a permanent establishment is relevant under Article 8 (Business Profits) to the taxation of industrial or commercial profits and in determining the applicability of other provisions of the Convention.

The term “permanent establishment” means a fixed place of business through which a resident of one of the Contracting States engages in industrial or commercial activity. Examples of a fixed place of business include a branch; an office; a factory; a warehouse; a workshop; a farm or plantation; a store or other sales outlet; a mine, quarry or other place of extraction of natural resources; a building site, or construction or assembly project, or supervision activity connected therewith and conducted within the Contracting State where such site or project is located, where such site, project of activity continues for a period of more than six months; and the maintenance of substantial equipment or machinery, including for example, a drilling rig, within a Contracting State for a period of more than six months. As a general rule, any fixed facility or premises through which a resident conducts industrial or commercial activity for an indefinite or substantial period of time will be treated as a fixed place of business unless it is used only for one or more of certain excepted/described activities.

The Convention specifically provides that a permanent establishment does not include a fixed place of business if it is used only for one or more of the following:

“(a) The use of acilities for the purpose of storage, display, or delivery of goods or merchandise belonging to the resident;
“(b) The maintenance of a stock of goods or merchandise belonging to the resident for the purpose of storage, display, or delivery (other than goods or merchandise held for sale by such resident in a store or other sales outlet);
“(c) The maintenance of a stock of goods or merchandise belonging to the resident for the purpose of processing by another person;
“(d) The maintenance of a fixed place of business for the purpose of purchasing goods or merchandise, or for collecting information for the resident;
“(e) The maintenance of a fixed place of business for the purpose of advertising, for the supply of information, for scientific research, or for similar activities which have a preparatory or auxiliary character, for the resident;
“(f) A building site, or construction or assembly project, or supervision activity connected therewith, where such site, project, or activity continues for a period of not more than 6 months, or
“(g) The maintenance of substantial equipment or machinery within a Contracting State for a period of not more than 6 months.”
 

As noted, a fixed place of business used only for one or more of these purposes will not be considered a permanent establishment under the Convention.

The Convention provides that even though a resident of one Contracting State does not have a permanent establishment in the other Contracting State under paragraphs (1), (2) , and (3) of the PE Article,  such resident will be deemed to have a premanent establishment in the other Contracting State if such resident sells in that Contracting State goods or merchandise which either were subjected to substantial processing in that Contracting State (whether or not purchased in that Contracting State), or were purchased in that Contracting State and not subjected to substantial processing outside that Contracting State.

The Convention provides that a person acting in one Contracting State on behalf of a resident of the other Contracting State, other than an agent of an independent status, will be deemed to constitute a permanent establishment if such person has, and habitually exercises in that first-mentioned Contracting State, an authority to conclude contracts in the name of the resident, unless the exercise of the authority is limited to the purchase of goods or merchandise for the resident.

On the other hand, the Convention provides that a resident of one Contracting State will not be deemed to have a permanent establishment in the other Contracting State merely because such resident engages in industrial or commercial activity in such other Contracting State through a broker, general commission agent, or any other agent of an independent status, where such broker or agent is acting in the ordinary course of his business.

The Convention provides that a resident of one Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because such resident sells at the termination of a trade fair or convention in the other Contracting State goods or merchandise which were displayed by such resident at the trade fair or convention. The trade fair exception is not intended to apply with respect to goods in the resident’s inventory.

The Convention provides that the determination of whether a resident of one Contracting State has a permanent establishment in the other Contracting State is to be made without regard to the fact that such resident may be related to a resident of the other Contracting State or to a person who engages in business in that other Contracting State (whether through a permanent establishment or otherwise). What is relevant is whether the resident of the other State carries on for the resident of the first-mentioned State an activity which, within the provisions of this Article, would make the resident of the other State a dependent agent of the resident of the first-mentioned State. As defined in Article 11(Related Persons), a person is related to another person if either person owns or controls directly or indirectly the other, or if a third person or persons own or control directly or indirectly both.

General Rules of Taxation

Under the Convention, a resident of one Contracting State may be taxed by the other Contracting State on any income from sources within that other Contracting State and only on such income, subject to the limitations set forth in the Convention. For this purpose, the source rules contained in Article 4 (Source of Income) are to be applied. However, if the resident is a citizen of the other Contracting State, that Contracting State may tax the resident without regard to such rules because of the saving clause.

The Convention contains the customary rule that the Convention will not restrict in any manner any exclusion, exemption, deduction, credit, or other allowance now or hereafter accorded by the laws of a Contracting State in the determination of a tax imposed by it, or by any other agreement between the Contracting States. Thus, if a deduction would be allowed under the Code for an item in computing the taxable income of an Israeli resident, such deduction is generally available to him in computing taxable income under the Convention. The Convention does not, however, authorize a taxpayer to make inconsistent choices between rules of the Code and rules of the Convention. In no event are the rules of the Convention to increase the U.S. or Israeli tax burden from what that liability would be if there were no Convention. Thus, a right to tax given by the Convention cannot be exercized unless that right also exists under the Code.

The Convention contains the traditional saving clause under which the United States reserves the right to tax its citizens and residents (determined under Article 3 (Fiscal Residence)) as if the Convention had not come into effect. However, the saving clause does not apply in several cases in which its application would contravene policies reflected in the Convention. These policies are specifically designed to extend treaty benefits to citizens or residents. Thus, the saving clause does not affect the provisions with respect to grants, charitable contributions, social security payments, relief from double taxation, nondiscrimination, or the mutual agreement procedure, which are available to residents and citizens of the Contracting States. Moreover, the saving clause does not affect the benefits of the Convention provided to individuals performing governmental functions, teachers, students and trainees, and diplomatic or consular officers who are neither citizens of, nor have immigrant status in, the Contracting State imposing the tax. In the case of the United States, “immigrant status” means the individual has been admitted to the United States for permanent residence. The saving clause is reciprocal.

The Convention reserves the right of the United States to impose its personal holding company tax under section 541 of the Code and its accumulated earnings tax under section 531 of the Code notwithstanding any provision of the Convention. However, the Convention also provides that an Israeli corporation will be exempt from the personal holding company tax in any taxable year unless the United States residents or citizens own, directly or indirectly, within the meaning of section 544 of the Code, ten percent or more in value of the outstanding stock of the corporation at any time during the taxable year. In addition, an Israeli corporation will be exempt from the accumulated earnings tax in any taxable year unless at least twenty-five percent of the voting stock of such corporation is owned by United States citizens or residents.

The Convention provides a special rule for cases where income dealt with by this Convention is taxable to a resident of a Contracting State only if, and to the extent, it is remitted to or received by that person. In certain cases, individuals who are residents of Israel are not taxable on foreign source investment income, unless it is remitted to or received by them in Israel. If such income is received outside of Israel or accumulated by the payer, an Israeli resident may not be subject to tax on that income. If the reductions in rates or exemptions from tax were to apply to those items of income, the United States would be foregoing tax where double taxation does not in fact occur. 

Business Profits (Article 8) 

The Convention sets forth the general rule that industrial or commercial profits of a resident of one Contracting State are exempt from tax by the other Contracting State unless the resident has a permanent establishment in the other Contracting State. Where there is a permanent establishment, only the industrial or commercial profits attributable to the permanent establishment can be taxed by that other Contracting State, unless the resident is a citizen of that other Contracting State. Industrial or commercial profits, whether otherwise treated as from sources within or without a Contracting State, which are attributable to a permanent establishment which a resident of one Contracting State has in the other Contracting State will be considered to be from sources within that other Contracting State. Thus, items of income described in section 864(c)(4)(B) of the Code attributable to a permanent establishment situated in the United States will be subject to tax by the United States. The limited “force of attraction” rule under Code section 864(c)(3) does not apply for U.S. tax purposes under the Convention.

In determining the proper attribution of industrial or commercial profits under the Convention, the Convention provides that both Contracting States will attribute to the permanent establishment such profits as it would reasonably be expected to derive if it were an independent entity engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the resident of which it is a permanent establishment. Expenses, wherever incurred, which are reasonably connected with profits attributable to the permanent establishment, including executive and general administrative expenses, will be allowed as deductions in determining the industrial or commercial profits of the permanent establishment. However, in determining the amount of certain deduction for expenses incurred by the head office, the deductions may be limited to the expense incurred without including a profit element for the head office.

The Convention provides that no profits shall be attributed to a permanent establishment merely because of the purchase of goods or merchandise by that permanent establishment, or by the resident of which it is a permanent establishment, for the account of such resident. 

The term “industrial or commercial profits” includes income derived from manufacturing, mercantile, banking, insurance, agricultural, fishing or mining activities, the operation of ships or aircraft, the furnishing of services, and the rental of tangible personal (movable) property. The term does not include income from the rental or licensing of motion picture films or films or tapes used for radio or television broadcasting, or income from the performance of personal services derived by an individual either as an employee or in an independent capacity.

Under the Convention, the term “industrial and commercial profits” also includes income from dividends, interest, royalties described in paragraph (2) of Article 14 (Royalties), and capital gains and income derived from property and natural resources, but only if the income is effectively connected with a permanent establishment. 

The Convention also contains criteria for determining whether income is effectively connected with a permanent establishment. Factors to be taken into account include whether the rights or property giving rise to such income are used in, or held for use in, carrying on an activity giving rise to industrial or commercial profits through a permanent establishment and whether the activities carried on through such permanent establishment were a material factor in the realization of the income. For this purpose, due regard will be given to whether or not such property or rights or such income were accounted for through such permanent establishment. The rules in this regard are similar to those found in section 864 of the Code.

Where industrial or commercial profits include items of income which are dealt with separately in other articles of the Convention, the provisions of those articles will, except as otherwise provided therein, supersede the provisions of the Business Profits Article. Thus, for example, taxation of interest income will be controlled by Article 13 (Interest) and not by the Business Profits Article unless the interest is attributable to a permanent establishment.

The Convention provides that the United States excise tax on insurance premiums paid to foreign insurers, imposed by section 4371 of the Internal Revenue Code, which is a covered tax under the Convention, will not apply to insurance or reinsurance premiums received by a business of insurance conducted by a resident of Israel regardless of whether that business is carried on through a permanent establishment in the United States. This provision applies only to the extent that the relevant risk is not reinsured, directly or indirectly, with a person not entitled to relief from such tax.

Under the Convention, no insurance excise tax (or income tax) is payable with respect to premiums paid to a resident of Israel if the resident does not have a permanent establishment in the United States. In the case of a resident of Israel with a permanent establishment in the United States, the United States will not impose the insurance excise tax. (See Revenue Ruling 80-225.)

Social Security Payments (Article 21) 

The Convention provides that social security payments and other public pensions, e.g., railroad retirement benefits, paid by one Contracting State to an individual who is a resident of the other Contracting State will be exempt from tax in both Contracting States.

Investment or Holding Companies (Article 25)

The Conventions provides that a corporation of one Contracting State deriving dividends, interest, royalties or capital gains from sources within the other Contracting State will not be entitled to the benefits of Articles 12 (Dividends), 13 (Interest), 14 (Royalties), or 15 (Capital Gains) if by reason of special measures the tax imposed on such corporation by the first-mentioned Contracting State with respect to such dividends, interest, royalties or capital gains is substantially less than the tax generally imposed by such Contracting State on corporate profits, and twenty-five percent or more of the capital of such corporation is held of record or is otherwise determined, after consultation between the competent authorities of the Contracting States to be owned, directly or indirectly, by one or more persons who are not individual residents of the first-mentioned Contracting State (or, in the case of an Israeli corporation, who are citizens of the United States). For purposes of these rules, the requisite direct or indirect ownership be tested at the individual shareholder level. Existing Code provisions dealing with the taxation of capital gains do not make this Article applicable with respect to capital gains.

The purpose of these provisions is to deal with potential abuse which could occur if one of the Contracting States provided preferential rates of tax for investment or holding companies. In the absence of this Article, residents of third countries could organize a corporation in the Contracting State extending the preferential rates for the purpose of making investments in the other Contracting State. The combination of low tax rates in the first Contracting State and the reduced rates of exemptions in the other Contracting State would enable the third country residents to realize unintended benefits.

Exchange of Information (Article 29) 

The Convention provides for system of administrative cooperation between the competent authorities of the two Contracting States by requiring an exchange of information pertinent to carrying out the provisions of the Convention or preventing fraud or fiscal evasion in relation to the taxes which are the subject of the Convention. The competent authorities may exchange information in connection with tax compliance generally, not merely illegal acts or crimes. Information exchanged must be treated as secret and cannot be disclosed to any persons or authorities other than those concerned with the assessment, including judicial determination, or collection of the taxes which are the subject of the Convention. Thus, disclosure is not prohibited as a part of a public proceeding before a court or administrative body.

The Convention, however, makes clear that a Contracting State is not obligated to carry out administrative measures at variance with the laws or the administrative practice of either Contracting State; to supply particulars which are not obtainable under the laws or in the normal course of the administration of either Contracting State; or to supply information which would disclose any trade, business, industrial, commercial or professional secret or trade process, or information the disclosure of which would be contrary to public policy.

In making such determinations, a Contracting State will use the standards it used in the enforcement of its own laws by its administrative and judicial authorities, treating the tax of the Contracting State with respect to which a request relates as if it were a tax of the Contracting State requested to furnish the information and were being imposed by such Contracting State. Depositions of witnesses and copies of unedited original documents (including books, papers, statements, records, accounts, or writings) may be provided by the competent authority of a Contracting State if specifically requested by the competent authority of the other Contracting State.

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