Your Taxes: Alternative-track woes
By LEON HARRIS
Israeli and foreign multinational corporations want to take out of Israel many billions of shekels that are trapped by the tax system.
Recent reports suggest that Israeli and foreign multinational corporations want
to take out of Israel many billions of shekels that are trapped by the tax
system. Tempers are rising on all sides. What’s it all about?
Law for Encouragement of Capital Investments, 1959, uses tax and grant
incentives to attract investment capital into Israeli industry, tech tourism and
agriculture. By and large, the law has succeeded in doing this, thereby
developing the Israeli economy and creating jobs and exports.
the mix of tax and grant incentives has changed periodically.
years the “alternative-benefits track” has gained a lot of traction.
is the ‘alternative-benefits track’?
Under this track, companies can opt for a
no grants and no tax package. No tax means no company tax on profits from a
specific project that meets various industrial or tech criteria. But there is a
sting in the tail: The company must retain those profits. If the company decides
to distribute those profits, two dollops of tax become due.
company must pay company tax at rates ranging from 10 percent to 25%, depending
on the degree of foreign ownership, plus dividend withholding tax at a rate of
15%. The resulting total Israeli tax hit therefore ranges from 23.5% to 36.25%
for a company on the alternative track that distributes a dividend.
alternative-benefits track is no longer on offer, but companies that opted for
it before 2011 stay on it unless they elected to switch to a new set of tax
breaks for “preferred enterprises.”
Preferred enterprises currently pay
company tax on all their profits at rates ranging from 5% to 15% (not 25%), and
dividends are taxed at 15%.
The resulting total Israeli tax hit therefore
ranges from 19.25% to 27.75% for a company with a preferred enterprise under the
new 2011 legislation that distributes a dividend.
What’s wrong with that?
There are several issues arising from the alternative-track tax
First, the Israel Tax Authority (ITA) takes the view that if a
company elected the alternative track, all it has to do to avoid tax is to
plough profits back into the company. That’s the law. And the very name
“alternative-benefits track” means the company could have elected different
benefits, such as cash grants and low tax.
Second, there are ways around
the alternative-benefits track tax charge.
For example, the company can
distribute other profits derived from different projects not on the
Alternatively, a foreign parent corporation
might consider borrowing money abroad using cash held by its Israeli subsidiary
as collateral. But the ITA might seek to challenge this.
A further course
of action might be to distribute the profits, pay the taxes and claim a foreign
tax credit if the shareholders are foreign residents.
turbo-charged exit is still possible. For example, if NIS 1 million of untaxed
profits are retained because of the alternative-benefits track, the company’s
value might increase by NIS 15m. if we assume a price-to-earnings ratio of 15.
The shareholders can then cash in their share of the gain by selling their
Foreign investors are usually exempt from Israeli capital-gains
tax. It is advisable to obtain a tax ruling confirming the change of ownership;
the ruling is possible if jobs and technology stay in Israel.
downward payments in a group?
The alternative-benefits track rules contain an
obscure but troublesome anti-avoidance rule (Section 51B(b)(1) of the Law for
the Encouragement of Capital Investments) that reads: “Each of the following
shall be regarded as a dividend distributed...
(1) An amount given by
an... enterprise to its relative, major shareholder as defined... or to an
entity in its control or which is charged to it directly or
Unfortunately, the ITA has been known to claim that such a
“dividend” includes “downward” investments by Israeli companies in a foreign
subsidiary company because the foreign subsidiary is indirectly controlled by
the major shareholders of the parent company.
For example, if an Israeli
company has untaxed retained profits of NIS 50m. and wants to invest NIS
in a subsidiary company it has in Asia, the NIS 10m. might be deemed
to be a taxable dividend by the ITA.
Most others disagree with this
interpretation of the law. How can a downward payment be a dividend to
shareholders? Surely this was not the intention of the Knesset as legislator?
Surely only “upward” payments to shareholders or for their benefit constitute
dividends? These issues remain unresolved.
The question of
planned dividends out of untaxed profits and “downward” payments to subsidiaries
has aroused controversy, which is said to be under review by the Israeli
This is urgent because investors abhor
With regard to dividends “upward” to shareholders, now that
Israeli tax rates have declined to 19.25% to 27.75% for “preferred enterprises,”
perhaps they should be substituted in cases of dividends out of untaxed profits?
With regard to “downward” payments to subsidiaries, clarification is needed that
these really are not dividends.
As always, consult experienced tax
advisers in each country at an early stage on all relevant aspects in specific
firstname.lastname@example.org Leon Harris is a certified public accountant and tax
specialist at Harris Consulting & Tax Ltd.