What happens when a manager of an international investment fund or hedge fund
makes aliya to Israel? Will the fund and all its investors get swept into the
Israeli tax net lock stock and barrel? This would cause a tax tsunami and deter
people worldwide from investing in such funds. It would also deter
immigration.
Over the years, the problem has arisen frequently and the
Israel Tax Authority (ITA) has issued tax rulings protecting foreign investors
of overseas funds from Israeli tax because of the huge amounts
involved.
But Israeli tax law is unclear in this area and doubts
remain. How much fund income is allocable to Israel? Are foreign
investors and foreign managers in the fund protected from Israeli taxation? What
about immigrants’ tax breaks? What about success fees? The ITA has just
published a topical new tax ruling on “The Allocation of Income To New
Immigrants Who Are Partners and Investment Managers In a Hedge Fund” (Ruling
4589/12). But deciphering the ruling requires special insights as discussed
below.
The facts of the ruling The ruling applicants were a group of
non-Israeli resident partners in an international hedge-fund group who wanted to
immigrate to Israel. They are said to be senior investment managers with broad
experience and goodwill. They are going to work for an existing Israeli company
in the group, which pays Israeli tax on its activities of “research and
development and managing and executing investments on behalf of the
group.”
They hold shares in a foreign company, the subject of the tax
ruling, which derives a share of management fees and success fees from other
entities and partnerships in the hedge-fund group around the world. The foreign
company does not market or seek clients in Israel, nor provide services to
clients in Israel, nor represent the group in Israel.
What the ruling
decided The ruling decided that a portion of the foreign company’s profits
should be assessed to Israeli company tax (currently 25 percent). That portion,
to be determined by reference to ITA Circular number 1/2011, is multiplied by
the share of profits actually distributed by the foreign company to the
immigrants concerned.
Other distributed profits qualify for the 10-year
Israeli tax exemption for foreign-source income of new Israeli residents and
“senior returning residents” (who lived abroad over 10 years). In addition, the
immigrants concerned must draw a salary not less than a prescribed amount from
the Israeli company.
Foreign-resident partners will not be taxed in
Israel on their share of income from the foreign partnerships in the group,
including dividends from the above-mentioned foreign company and its
subsidiaries.
The ruling is valid for up to 10 years, so long as the
immigrants hold no more than 9.9% of the rights in the foreign
company. Now we know. Or do we?
What does the ruling mean? The olim
hedge-fund managers will apparently generate a 25% Israeli company tax liability
on profits distributed to them multiplied by the pro rata portion of days they
work in Israel (per Circular 1/2011). And they will pay Israeli tax (at rates of
up to 50% plus National Insurance Institute payments in 2013) on their
prescribed salary from the Israeli company.
Foreign-resident partners
will not be taxed in Israel on their share of income from the foreign
partnerships in the group, including dividends from the above-mentioned foreign
company and its subsidiaries.
Pertinent comments This ruling seems worthy
of Sir Humphrey in the BBC series Yes Minister; it means whatever it means.
Numerous comments arise from the ruling, including the following: First, it is
good to know that foreign-resident partners will not be taxed in Israel – but
does this cover all foreign investors? Second, why is the foreign company
taxable in Israel? Does it have a permanent establishment in Israel according to
a tax treaty? If no tax treaty with Israel applies, is the foreign company doing
business in Israel? These are serious omissions.
Third, will the profits
distributed to the immigrants also attract Israeli dividend withholding tax –
presumably 25% in this case? Fourth, will the Israeli taxes be put postponed
indefinitely by not distributing the profits? Or by distributing after the
10-year ruling term is over? Fifth, the pro rata formula regarding days worked
in Israel is open to many interpretations. It also falls short of OECD guidance
on allocating income between countries. Israel joined the OECD in
2010.
Some concluding remarks For tax practitioners in the funds field,
the ruling leaves too much unsaid. The ITA wants to tax fund managers in Israel
even if they are immigrants but leaves vague the grounds and the amounts.
Therefore, anyone in this situation should take appropriate advice on how to
reduce any Israeli tax with greater certainty.
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. leon@hcat.co