Shekel money bills.
(photo credit: REUTERS)
On January 1, 2017, a new tax treaty became effective between Israel and Canada (the new treaty), replacing an earlier tax treaty dating back to the 1970s (the old treaty). Below is an overview.
The new treaty covers residents of either or both countries.
It also applies to the income of a partly or wholly fiscally transparent company, partnership, trust or other entity to the extent the income is treated as income of a resident of the country concerned. Tie-breaker rules exist for dual residents that are resident in both countries under each country’s domestic law.
For dual resident entities, the tie-breaker rule requires the two countries’ tax authorities to reach agreement in regard to effective management, place of incorporation and other relevant factors; until then a dual resident entity cannot claim any treaty relief or exemption.Taxes covered
In addition to taxes on income and capital gains, the treaty covers taxes imposed by Israel on gas under the Petroleum Profits Taxation Law, 5771-2011.Recognized pension plans
These have now been defined to include any Canadian pension plan, arrangement or contract described in Article 5 of the Canadian Income Tax Conventions Interpretation Act; and any Israeli pension provident fund approved under the Control of Financial Services Act (Provident Funds), 2005. The paying country is allowed to impose a 15% withholding tax on pensions and annuities, except for lump sum payments on surrender, cancellation, redemption or sale of annuity.Permanent establishment
A taxable PE is essentially a fixed place of business or a “dependent agent” in one country of an enterprise from the other country. A PE includes: a gas well, any other place for exploiting natural resources, a building site or construction or installation project lasting more than 12 months.
A PE may not include a warehouse solely for storage, display or delivery of goods – this apparently does not reflect a recent tightening of OECD rules aimed at warehouses of e-commerce operators. Independent agents (not PEs) may include related parties, again contrary to a recent tightening of OECD rules.
If one country makes an adjustment to the profits of a PE, the other country should make a corresponding adjustment to the extent necessary to avoid double tax.Shipping and airlines
If Israeli lines take on people or goods in Canada for “discharge” in Canada, Canada may tax the profits, and vice versa.Dividends, interest and royalties
The old tax treaty imposed a flat withholding tax of 15% on dividends, interest, royalties and other income paid to residents of the other country.
With regard to dividends, the new treaty generally stipulates a 15% withholding tax in the payor country, but may reduce it to 5% if the recipient is a company holding at least 25% of the capital of the payor. The rate is zero for certain recognized pension plans. The rate is 15% for Israeli REITs that pay dividends to Canadian resident investors holding under 10% of the REIT’s capital (unless the investor has a PE in Israel), otherwise, domestic law applies in both countries.
The Canadian branch tax is limited to 5% on branch remittances to Israel. Israel generally doesn’t impose such a tax.
With regard to interest, the new treaty generally stipulates a 10% withholding tax in the payor country, reduced to 5% for interest paid to a financial institution. A withholding exemption may apply in cases involving certain recognized pension plans, governmental bodies and export credit bodies.
With regard to royalties, the new treaty generally stipulates a 10% withholding tax rate but grants a withholding tax exemption for artistic royalties (not films or TV), computer software and knowhow (not rental or franchising).Capital gains and exit tax
Gains from real estate held directly or via a trust may be taxable in the source country. Most other capital gains are only taxable in the country of residence of the taxpayer. The treaty expressly allows each country to impose its “exit tax” on individuals who migrate from one country to the other – the other country generally cannot tax the gain concerned.Double Taxation
Double taxation is avoided by a system of foreign tax credits.
The old treaty allowed enlarged credits for taxes spared (not paid) due to Israeli tax breaks. This enlarged “tax sparing” credit is gone in the new treaty.
The new treaty allows both countries to apply domestic rules against “thin capitalization” – not defined – presumably excessive interest expense deductions. Also certain service trade disputes under GATT or World Trade Organization rules (regarding most favored nation treatment, etc) may only be brought before the WTO Council for Trade in Services with the consent of both Israel and Canada.Comments
Canadians and Israelis should obtain advice on the implications of the new treaty. Many points of detail have been amended.
As always, consult experienced tax advisers in each country at an early stage in specific cases.
firstname.lastname@example.org The writer is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.