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? The background The 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.Since 1959, the mix of tax and grant incentives has changed periodically.In recent years the “alternative-benefits track” has gained a lot of traction.What 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.First, the 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.The 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 charge.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 alternativebenefits track.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.Third, a 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 shares.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.What about 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 indirectly.”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 10m.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.Some comments 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 government.This is urgent because investors abhor uncertainty.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.