Office desk 370.
(photo credit: Wikicommons)
The Israel Tax Authority (ITA) has published an anonymous tax ruling in which an
Israeli investor apparently got it all wrong regarding a US LLC and tragically
paid unnecessary Israeli tax.
The facts of the
For US tax purposes, an LLC (limited
liability company) is usually a transparent “flow through” entity, meaning the
members (shareholders) are taxed, not the LLC itself.
The ruling (2536/12 of June 24, 2012) describes a case in which an
Israeli parent company held apparently 100 percent of a private US subsidiary
company (“daughter company”).
The daughter company had no business
activity but reported its income to the US Internal Revenue Service (IRS),
making it a “C-Corporation” for US tax purposes.
The daughter company
held a 49% interest in a US LLC (“granddaughter company”).
structure was: Israeli parent company–> US CCorporation Daughter Co. (100%
owned)–> US LLC granddaughter Co. (49% owned).
According to the
ruling, the Israeli parent company asked the ITA for a foreign tax credit for
tax paid by the LLC: (1) pursuant to domestic Israeli tax law; or (2) under the
US-Israel tax treaty; or (3) by treating the LLC as a transparent flow-through
entity for Israeli tax purposes and attributing its income to the
In general, Israeli tax law allows an Israeli resident
company to credit the foreign corporate income tax of 25%- or-more affiliated
(daughter) companies and their 50%-ormore subsidiary (granddaughter) companies.
This is known as an underlying, or indirect, tax credit.
Israeli tax law
also generally allows a direct credit for foreign withholding taxes on dividends
and other payments to the Israeli resident company.
All this applies to
foreign federal and state taxes on income and gains, but not city
The ruling result
According to the ruling, the ITA turned down
flat the Israeli company’s request for a foreign tax credit.
states: “It is not possible to treat the granddaughter company as a
“partnership” (i.e., transparent) as it is incorporated as an LLC and is
considered as a “company” according to the Israeli tax laws. Therefore the
granddaughter’s income is considered its own, even though the income is
attributed to the daughter company according to the US tax
Consequently, as the LLC was not transparent for Israeli tax
purposes and was not 50% owned by the daughter company (only 49%), the Israeli
company got no underlying tax credit for US taxes on the LLC’s
The result was apparently double taxation in the two
countries.What can we learn from all this?
First, an LLC is generally
not transparent in Israel, even if it is transparent in the US (but see
Second, the US-Israel treaty made no difference. In fact, the
treaty does not deal with granddaughter companies.
Third, the taxpayer
apparently forgot to do advance tax planning; the double-tax result in this case
The ruling reads like a last vain attempt to pull
chestnuts out the fire.What else could the Israeli taxpayer have done?
The ITA has published a circular (5/2004 dated April 19, 2004, allowing Israeli
taxpayers to elect flow-through treatment for an LLC in the first relevant tax
return. It appears this is also possible for LLC granddaughter
This means reporting the LLC income that year and every year
and crediting applicable US federal and state tax thereon.
S-Corporations, the circular allows an Israeli taxpayer to apply to the ITA for
relief, but it is unclear what will be granted. The circular aims to avoid
double tax but does not allow foreign losses to be offset against Israelisource
Other possibilities involving “family company” rules in the
Israeli tax law may also have been possible, depending on the facts. A family
company is fiscally transparent in Israel, if so elected, and is owned by a
company owned entirely by people from one family. Detailed rules apply to
“family companies,” which need to be checked out in each case. A family company
does not have to be an Israeli company.
To elect or not to elect
electing LLC transparency for Israeli tax purposes, prepare alternative
calculations of the taxes in the two countries. Sometimes, if an Israeli
investor has low US income, transparency may arithmetically be a bad
Not electing LLC transparency may also postpone Israeli taxation
until the Israeli taxpayer actually receives income; i.e., why pay tax on
undistributed LLC income?To sum up
Do your tax-planning homework in advance,
not when it’s too late. With an LLC you must work out what is best for you in
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.