Your Taxes: Tips you need to know about exporting

Companies export for one reason only: to make a profit, net of all taxes. The following article highlights a few ways in which taxes can be minimized and the profits of Israeli exporters and foreign exporters to Israel can be optimized. The advice is applicable to exporters delivering products physically, over the Internet or providing services.

Customs duties

Israel has free-trade agreements (FTAs) with a number of countries, including the European Union, the United States, the European Free Trade Association (EFTA), Canada, Mexico, Mercosur (Argentina, Brazil, Paraguay and Uruguay) and Turkey, but none with South Africa or Australia.

The Israel-EU FTA

The Israel-EU free-trade agreement (also known as an Association Agreement) should reduce or eliminate customs duties originating in the EU for delivery to Israel and vice versa.

Briefly, the goods should qualify under the agreement if they undergo processing that result in the finished product having a different customs product code from all the imported raw materials, at the four digit product-code level. The processing should also meet the requirements set out in Annex 2 of Protocol 4 of the Agreement. It is advisable to consult your customs agent for more details in theory and in practice.

The Israel-US FTA

The Israel-US FTA generally applies to any article if: (a) that article is wholly the growth, product or manufacture of a party, or is a new or different article of commerce that has been grown, produced or manufactured in one of the two countries; (b) that article is imported directly from one country into the other; and (c) the sum of: (i) the cost or value of the materials produced in the exporting party, plus (ii) the direct costs of processing operations performed in the exporting country is not less than 35 percent of the appraised value of the article at the time it enters into the other country.

Other FTAs have similar but not identical ‘‘source rules” for qualifying products.

VAT

Never underestimate VAT. The standard rate of VAT in Israel is 16%, rising to 17% on September 1, and is even higher in some other countries; for example, 20% in the UK. Remember these rates are on your sales price, not just on profits! VAT on imported goods is normally collected by the Customs authorities.

Each country has complex rules to catch the VAT due in the area of services and e-commerce.

For Israeli and other non-EU exporters who supply services to EU business customers (B2B, or business to business), most services will be treated as supplied where the business customer is established (i.e., an EU country) and the business customer will itself account for VAT under a reverse charge (selfbilling) mechanism.

In the case of B2C (business to consumer), the Israeli/non-EU supplier should account for any EU VAT due. In the case of electronically supplied services to EU consumers, the Israeli/non-EU supplier may opt to use a special scheme.

Subject to certain conditions, the special scheme offers Israeli and other non-EU businesses the option of registering electronically in a single EU member state of their choice.

They can then account for VAT on their sales of electronically supplied services to all EU consumers on a single quarterly electronic VAT declaration that provides details of VAT due in each member state. This is submitted with payment to the tax administration in the member state of registration, which then distributes the VAT to the member states where the services are consumed.

You cannot recover VAT on purchases using the special scheme.

However, you may reclaim any VAT that you have paid on goods and services used for the purpose of your taxable activities falling under the special scheme from the member state where that VAT was paid, under the terms of the EU 13th Directive. (For more details see the UK‘s HMRC Notice 741A among others.) In the case of non-Israeli service suppliers, they should, in theory, account for Israeli VAT on services supplied to Israeli residents.

In practice, enforcement is weak if the service supplier doesn’t do business in Israel. If it does do business in Israel, it should register for Israeli VAT purposes and appoint an Israeli resident fiscal representative within 30 days.

Income/corporation tax

Exporting usually follows an evolutionary process. For a novice exporter it may be sufficient to make a sale from their own country and to ship the product to a distributor abroad. The distributor should know the local market conditions best. The exporter will not have to pay corporation tax in the other country if it can avoid having a “permanent establishment” (PE) as defined in the relevant tax treaty.

Israel has tax treaties with 50 other countries, including the US, Canada, South Africa, most EU countries, but none with Australia.

In practice, a PE generally means a ‘‘fixed place of business” (a branch) or a “dependent agent” (agent with few other customers and/or concludes sales on behalf of the exporter). In the case of electronic commerce, the OECD indicates that a smart server that does deals, and not only gives out your address, is a PE.

Where a PE exists, corporate income tax is due on profits attributable to the PE. The standard rates of corporate income tax (company tax) are 25% in Israel, 35% federal income tax in the US (plus state and city taxes where applicable), 20%- 24% in the UK and so forth.

Foreign residents must appoint an Israeli resident fiscal representative, who can be the same as their VAT representative.

In practice, exporters often move on from distributors to setting up their own dedicated subsidiary company. Israeli exporters often use a US subsidiary to sell across North America and a UK subsidiary to sell into EU markets. Currently Israel is waiting patiently (and hopefully) for non-Israeli exporters to use Israel as a hub into other Mideast countries.

Transfer pricing

Most global trade is conducted via multinational groups. This is because a local subsidiary can sell products to the local market better than the foreign exporter. Israel and most other countries have detailed rules requiring multinational group members to transact with each other on arm’s length terms. This is meant to prevent tax planning but usually has the opposite effect.

Withholding tax

Companies are often surprised to find that tax is withheld at source from cross-border payments relating to items such as dividends, interest, royalties, software license payments, franchise fees, capital gains and so forth. The banks in Israel are obliged to withhold 25% from outbound payments unless advance written clearance is obtained from the Israel Tax Authority; e.g., pursuant to a tax treaty.

The US-Israel tax treaty specifies the following withholding tax rates:

• Dividends: 12.5%/15%/25%
• Interest: 17.5% or regular tax on the interest spread
• Royalties: 10%/15%
• Capital-gains tax: regular rates in most cases, except share sales by investors with under 10% of the investee company’s voting power.

The UK-Israel tax treaty specifies the following withholding tax rates:

• Dividends and interest: 15%
• Royalties: 0% or 2.4%-2.5%
• Capital gains: 0%, except for real-estate deals.

Concluding remarks Exporting requires a detailed knowledge of local tax rates and other rules. After you have this information you will be able to plan your corporate structure and business model accordingly.

As always, consult experienced tax advisers in each country at an early stage in specific cases.

leon@hcat.co

Leon Harris is an Israeli certified public accountant and tax specialist at Harris Consulting & Tax Ltd.