One of the many reasons for Israel’s economic success is that its trade and commerce with the rest of the world is supported by income-tax treaties with 50 other countries, as well as an array of freetrade agreements, R&D pacts and social-security totalization treaties.
What is the status of tax treaties in Israel?
But are the income-tax treaties fairly applied by Israeli tax officials? If there was any doubt in the past, it is important to note there is a new tax sheriff in town, in the unlikely guise of the Organization for Economic Cooperation and Development (OECD). Israel joined the OECD last September. Below is an overview of the anticipated implications.
According to Section 196 of the Income Tax Ordinance, the finance minister can give effect to a tax treaty whenever he deems it useful, and this will prevail over any other law. Tax treaties matter because international trade accounts for a relatively large part of Israel’s GNP.What does the OECD do?
The OECD has 34 members, including Israel. Its mission is to
promote policies that will improve the economic and social well-being of
people around the world. A Finance Ministry press release last May
predicted that Israel’s accession to the OECD would have the following
• Attract foreign investors
• Positive influence on Israel’s credit rating
• Compliance with OECD standards for activities in international
markets, including OECD tax agreements and anti-corruption rules
• Learning from the “best practices” of member countries in the
organization • Analyzing social needs and establishing ways to decrease
inequality and social gaps • Implementing reforms in the area of
environmental protection.How will the OECD affect our fiscal policy?
The OECD publishes a model tax treaty and commentary that give guidance
to governments and taxpayers about similar actual tax treaties. In
addition, the OECD has guidelines regarding transfer pricing between
The introduction to the OECD model convention states: “Member countries,
when concluding or revising bilateral conventions, should conform to
this Model Convention as interpreted by the Commentaries thereon and
having regard to the reservations contained therein... and their tax
authorities should follow these Commentaries, as modified from time to
time... subject to their observations thereon.”
The Israel Tax Authority has itself issued a Circular (17/2003) that
says: “It is accepted to regard commentary published by the OECD as the
accepted commentary in the international arena.”
Therefore, it seems that if the Israel Tax Authority disagrees with the
OECD commentary, it must now apply the OECD commentary unless the
Israeli government has entered a reservation or observation.
This is a major development that seems likely to influence the
administration of Israeli tax law if Israel is to meet its obligations
to the OECD.Israeli reservations about OECD Model Tax Treaty
So far, the Israeli government has entered only a few reservations or observations on the OECD model convention.
Two notable reservations state Israel’s intention to include trusts in
the definition of a “person” covered by Israeli tax treaties. This is
despite a trust being defined in the Israeli Trust Law and Income Tax
Ordinance as an “arrangement” (not a separate legal person) whereby
someone holds assets for someone else.
Also, Israel reserves the right to insert a provision whereby a
permanent establishment (taxable fixed place of business) shall exist if
an installation, drilling rig or ship are used for activities connected
with the exploration of natural resources.How does the OECD benefit the taxpayer?
The OECD model commentary may be relevant in two ways: by providing
guidance on aspects not covered by Israeli tax law or treaties; and by
counteracting any less-thanreasonable interpretation by the Israel Tax
Below are a number of examples regarding situations likely to be controversial in Israel.
Since “there is nothing new under the sun,” many of these controversies
have already been addressed by the OECD model treaty commentary, in
particular in a 2010 update.Investment funds
Until now, mutual funds and other investment funds have faced difficulty
in obtaining treaty benefits (reduced withholding tax rates or
exemption) in countries where they invest, because such funds typically
have many investors from many countries. Also the investment fund may be
established as a unit trust or a company or a limited partnership.
For example, how can a fund quickly claim treaty benefits ahead of a
declared dividend distribution? The OECD model treaty commentary
clarifies that widely held “collective investment vehicles” should be
treated as resident for treaty purposes in the country where they are
established, to the extent of their “equivalent beneficiaries.”
An “equivalent beneficiary” is a resident of the same country, or
another country that: (a) has a tax treaty with the incomesource
country, with effective and comprehensive information exchange rules;
and (b) the tax rate is the same or lower under a treaty or domestic
According to the OECD, it is sufficient to check the applicability of
these conditions “no more often than the end of each calendar quarter,”
or take it for granted if the fund is publicly traded in the country
where it is established. Pension funds and sovereign wealth funds may
also be expressly exempted.
The Israel Tax Authority needs to be satisfied upfront about eligibility
of foreign investors to treaty benefits or to a domestic capital-gains
tax exemption upon a sale of Israeli securities. Otherwise the regular
withholding tax rate for foreign residents of 25 percent is typically
With regard to foreign hedge funds that have an Israeli resident
manager, benefits have been granted in the past regarding foreign
investors, but such applications are rigorously scrutinized at present.
It seems the OECD 2010 update will be helpful in Israel.Electronic commerce
Israel doesn’t have any specific rules on this, but the OECD
model convention and commentary do. According to the OECD, a permanent
establishment does NOT include an Internet site, ISP hosting, providing a
communication link, advertising of goods and services, relaying
information through a mirror server, gathering marketing data and
supplying information over the Internet. But a permanent establishment
does include an unmanned server engaged in e-tailing sales and commerce
over the Internet.Satellite transmission
The question has often arisen whether a satellite in orbit could
be considered a permanent establishment (taxable fixed place of
business) in the receiving country. The OECD model treaty commentary
clarifies that no member country would agree that the location of these
satellites can be a part of the territory of a country under the
applicable principles of international law.
Also the area over which a satellite’s signal can be received (the
satellite’s “footprint”) cannot be considered to be a place of business
of the satellite’s operator. Even if the customer “leases” a satellite
transponder, this is really a services transaction and is not taxable as
a lease transaction, according to the OECD.Telecommunication roaming agreements
It is common for telecom operators of one country to enter into a
“roaming agreement” with a foreign operator to allow its users to
connect to the foreign operator’s telecom network. The OECD model treaty
commentary clarifies that under a typical roaming agreement, the home
network operator does not have physical access to that network and
cannot therefore constitute a permanent establishment of that operator.Cable, pipeline, other equipment in Israel
With regard to a cable or pipeline that crosses another country, the
OECD model treaty commentary clarifies that a customer whose data, power
or property is transmitted merely obtains transmission or
transportation services, not access to a pipeline or cable. In
consequence, the pipeline or cable cannot be considered to be a
permanent establishment of the customer – nor of the operator if the
operator merely delivers its own property.
Even if the customer “leases” a cable, this is really a
communication-services transaction and is not taxable as a lease
transaction. By contrast, the US-Israel Tax Treaty deems the presence of
substantial equipment or machinery for more than six months to be a
permanent establishment, and the Israel Tax Authority sometimes applies
this principle to equipment owners from other countries too.
It remains to be seen whether the OECD clarification regarding cable and
pipelines will change the Israel Tax Authority’s approach to equipment
of a foreign party in Israel.What’s in it for the Tax Authority?
The Israel Tax Authority may also gain from the OECD accession: Anti-abuse rule
The OECD model treaty commentary has a discussion on preventing “treaty
shopping”; i.e., use of a tax treaty between two countries by a resident
of a third country. The OECD Commentary says: “States do not have to
grant the benefits of a double-taxation convention where arrangements
that constitute an abuse of the provisions of the convention have been
entered into.Visiting personnel
Most tax treaties exempt visiting personnel from local tax if they are
present less than 183 days in the tax year and employed by a foreign
resident employer and their cost is not borne by a local permanent
The OECD model treaty commentary tightens up this requirement by saying
it is a matter of domestic law whether services are rendered by an
individual in an employment relationship.
This involves focusing primarily on the services rendered and their
integration into the business carried on by the enterprise that acquires
their services. So if a visiting individual effectively has an
employment relationship with an Israeli customer, the individual may
forfeit any treaty exemption from Israeli tax he may otherwise have
The OECD provides its own employer-employee relations tests, including:
authority to instruct, responsibility for the work place, salary
recharge, supply of tools and materials, determination of the number of
individuals and their qualifications, right to select personnel, right
to impose disciplinary sanctions, determination of holidays and work
To sum up, Israel’s accession to the OECD is likely to help
taxpayers and the Israel Tax Authority to better understand the meaning
of Israel’s tax treaties. This is likely to impact any request to invoke
a tax treaty.
As always, consult experienced tax advisers in each country at an early stage in specific cases.[email protected]
Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.