The Israel Tax Authority (ITA) has published a tax ruling (number 1312/12) that
will affect joint ventures between Israeli and non-Israeli firms. Action should
be taken as briefly discussed below.
In this case, an Israeli
trading company intended to set up an unregistered partnership (joint venture,
or “JV”) with a foreign company resident in an unnamed country that has a tax
treaty with Israel. Ownership, income and expenses of the JV would be
split 50:50 between the two companies. The purpose of the JV was to develop
communications products in the other country using people resident
there. The JV would then go for global sales. The planning, marketing and
advice to clients would take place in Israel.
Nevertheless, part of the
marketing would take place “directly and/or by means of regional agents or
distributors.” None of the shareholders of the foreign company were ever
Israeli residents. No intellectual property would be transferred to the JV or
the shareholders of the Israeli company, directly or indirectly.
The ITA ruled that the JV represents a taxable “permanent
establishment” (see below) of the foreign company in Israel according to the tax
treaty of its country of residence with Israel. This means the foreign company
must open an Israeli tax file, file Israeli tax returns and pay Israeli tax on
income attributable to the permanent establishment. And to make sure, the
Israeli company is “assessable and chargeable” to Israeli tax as a
representative of the foreign company, pursuant to Section 108 of the Israeli
Income Tax Ordinance.
The allocation of profits for Israeli tax purposes
between Israel and elsewhere would not necessarily be 50:50; it would be
according the transfer pricing rules in the Israeli tax law and the relevant tax
The ruling had another twist. Employees of the foreign company
would also be taxable in Israel according to the relevant tax
Finally, the ruling lays claim to Israeli capital-gains tax
should the JV ever be sold, in accordance with the Israeli tax law and the
relevant tax treaty.
This ruling is bad news for Israeli and
foreign businesses and their employees. Many international deals are
structured as JVs for a variety of commercial reasons: to create synergy, use
the other party’s connections, and so forth.
If double tax arises, the
foreign company may be able to claim a foreign tax credit for the Israeli tax,
but not always; e.g., if the tax authority in the foreign company’s home country
disagrees that a permanent establishment exists in Israel. And the
foreign company may not want the administrative bother of tax reporting in
Israel in Hebrew on approved Israeli accounting software, in addition to
reporting in its home country.
Furthermore, not discussed in the ruling
is the possibility that the Israeli company and its employees might be deemed to
be taxable in the other country concerned, applying the same
What is a permanent establishment?
Israel is a member of the
Organization of Economic Cooperation and Development (OECD), and Israeli tax
treaties generally follow the OECD model tax-treaty definition.
essentially says: The term “permanent establishment” means: a fixed place of
business through which the business of a foreign enterprise is wholly or partly
carried on; or a “dependent agent” acting on behalf of a foreign enterprise that
has, and habitually exercises, in Israel or the other treaty country concerned,
an authority to conclude contracts in the name of the foreign
What went wrong in this case?
The ruling does not say why a
permanent establishment was deemed to exist. We can only guess that the
foreign company had use of offices in Israel, or that the Israeli company was
expected to habitually sign sales agreements of the JV in Israel.
should others learn from this ruling?
We don’t know why the JV structure above
was adopted; it might have been to save costs. It was probably not to reduce
Israeli tax, as there are usually easier ways of arriving at a similar tax
Nevertheless, international concerns thinking of entering into a
JV with an Israeli company should beware of various potential obstacles,
including: using a partnership (registered or unregistered, see below); sharing
profits and losses; signing JV sales in Israel.
In practice, such
international JVs are usually structured differently.
Surprisingly, there are at least two similar precedents where havoc was
eventually averted. First, the ITA made similar claims a decade ago against
international venture-capital funds that invested in Israel, costing Israel
billions of investment dollars. These involved limited partnerships registered
in Delaware and elsewhere. Eventually, the ITA backed down and made a
pact with the VC funds.
And in the 1980s in the UK, international
investors stayed away from the City of London because of the same provision as
Israel’s Section 108 in the UK tax law.
The UK government headed by
Margaret Thatcher had to change the law to help save the London financial
To sum up
International JVs involving Israeli companies may
need restructuring in light of the ITA’s misguided ruling.
consult experienced tax advisers in each country at an early stage in specific
Leon Harris is a certified public accountant and tax
specialist at Harris Consulting & Tax Ltd.