When Superman streaks through the sky to do battle with evil, people wonder "Is it a bird or is it a plane?" But Superman is for kids. For adults, there is something else reminiscent called a limited liability company (LLC) in the US for which people wonder "Is it a corporation or is it a partnership?"
An LLC is a company incorporated under the laws of one of the states of the United States of America. An LLC does not have shareholders, but rather members. An LLC is generally disregarded for US tax purposes and, instead, its members (owners or partners) are taxed. In practice, LLCs are often formed in the State of Delaware for administrative ease. They are relatively cheap to form and run.
It is essential that the LLC has business substance (own employees, premises, etc) and is not controlled and managed in Israel - i.e. a majority of directors are Israeli residents located outside Israel and all daily and strategic decisions and activities take place Israel. Otherwise, full Israeli taxation will apply and double taxation or worse is sometimes possible (US, Canada, Belgium, Israel).
What are the advantages of an LLC? An LLC generally is treated as a "transparent" entity for US tax purposes, which means that the LLC is disregarded for domestic US tax purposes. Consequently, the LLC's owners may be assessable individually based on their status, if any, in the US. So, if the owners are US persons, an LLC may help them enjoy low US federal tax rates on capital gains: 15% plus state tax for assets held over a year).
In addition, an LLC will generally afford limited liability legal protection to its members.
Most interestingly, the owners of an LLC may not be taxable in the US if the owners are not US residents, US citizens or US green card holders, assuming the LLC conducts no business in the US and derives no income in the US. This makes an LLC potentially an offshore vehicle for Israeli resident members who operate or invest outside the US and Israel (but see below). Business and investments made in the US via an LLC US will be exposed to US taxes, including estate tax.
Since 2003, Israeli residents have been taxable in Israel on all their worldwide income and gains. So how is an LLC treated for Israeli tax purposes?
The Israeli Income Tax Authority (ITA) released Circular 3/2002 regarding LLCs, dated February 18, 2002. This Circular clarifies that an LLC would be viewed as a body of persons as defined in Section 1 of the Israeli Tax Ordinance. Furthermore, the Circular states that an LLC would not be subject to treaty protection according to the US-Israel tax treaty.
A more recent Israeli tax Circular number 5/2004 is dated April 19, 2004, and allows an Israeli taxpayer/member to elect for the LLC to be transparent for foreign tax credit purposes but not for other purposes (e.g. losses).
Therefore, an individual Israeli resident taxpayer can choose to pay tax income derived via an LLC by either 25% Israeli tax on any distribution with no foreign tax credit (no transparency election) or 49% Israeli tax immediately with foreign tax credit (transparency election).
A taxpayer choosing to apply the provisions of the Circular must make a decision with regards to the method of taxation they elect at the outset and act consistently in future years.
A taxpayer choosing to apply the provisions of the circular will attach a declaration to this effect to his/her tax return. The declaration will include the method of calculation of the taxable income and the amounts of the tax paid in the foreign country in respect of which the foreign tax credit is requested.
In the event that a taxpayer elects transparency and in one of the years a loss is incurred as a result of activity of the transparent entity, the losses will be offset at the level of the LLC entity in the following years.
To sum up, an LLC has a US veneer and gives greater flexibility to members (owners) who are Israeli residents. Furthermore, if those members are not also US citizens or green card holders, they may find the LLC a useful vehicle for business and investments outside Israel and the US (e.g. UK real estate investments) but they should review the tax anti-avoidance rules in each country.
Furthermore, other options may exist such as an Israeli "family" company - transparency can be elected for Israeli tax purposes and even for US tax purposes if a "check the box election" is filed with the US within 75 days after formation.
That would certainly not be a bird nor a plane, but it would be something else that may minimize double taxation in the US and Israel.
Each case should be checked out for all years concerned with experienced tax advisors.
The writer is an International Tax Partner at Ernst & Young Israel