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Australia is more than a country, it is a continent well endowed with minerals and other natural resources. Consequently, opportunities abound there. Other advantages include a population of around 21 million affluent English speakers, a gateway to the Asia-Pacific region and a legal system based on UK and US principles - rather like the Israeli system.
Perhaps the only thing in short supply in Australia is water, but have no fear, help is at hand. Israeli Infrastructures Minister Binyamin Ben-Eliezer recently signed an agreement with Malcolm Turnbull, Australia's Minister of the Environment, under which Israel will share its vast and unique knowledge of water management in return for Australia's financial backing of future Israeli projects based on water technology (The Jerusalem Post, March 20, 2007 - "Israel signs water deal with Australia").
The Post also reported that in 2006, 22 Israeli companies opened branches in Australia, bringing the total number of Israeli companies with operations there to over 1,300, while trade grew to $362 million, according to Yechiel Assia, director-general of the Israel Export Institute. Trade with Australia is expected to increase six percent to $383m. this year.
And on December 7, 2005, Vistech, the Victoria-Israel Science and Technology R&D Fund, was officially launched in Melbourne by the Australian Minister for Innovation, John Brumby. Vistech will fund up to 50 percent of the eligible joint R&D costs of Israeli-Victorian market-oriented projects in areas like biotechnology, water, environmental technologies, healthcare and advanced manufacturing.
Nevertheless, there is no tax treaty in force between Israel and Australia, so the general tax laws of each country need to be reviewed.
Australia has made significant changes to its international taxation regime over recent years in order to maintain Australia's status as an attractive place for business and investment. In particular, a number of the reforms have made Australia more competitive with other Asia-Pacific jurisdictions, as a regional holding company location.
An investor considering investment into Australia needs to consider the most appropriate investment vehicle and the taxation implications arising from that investment. Ideally, the investment should be structured to minimize the total taxation impact when profits are distributed back to the individual investor or the entity's shareholders or equity owners. Different profit repatriation considerations and taxation implications arise from the use of different investment vehicles, some of which are discussed below.
A non-Australian resident individual investing directly into Australia is subject to Australian tax on income derived from Australian sources and capital gains tax on assets that are taxable Australian property.
Non-Australian resident individuals pay tax on the very first dollar of taxable income, with the rate of tax increasing as their taxable income increases. However, where individuals receive dividends, royalty or interest income from Australian sources, such income is not included in their taxable income, but is subject to withholding tax, which is their final liability to Australian taxation. The Australian withholding tax rates for dividends, royalty and interest income remitted to residents in Israel are 30%, 30% and 10%, respectively. If the dividends paid by the Australian company are fully franked (i.e. paid out of corporate profits taxed in Australia) there will be no Australian withholding tax liability when the dividend is paid to an Israeli resident.
Non-Australian resident investors may choose to channel their investments in Australia through a general law partnership. Partners in Australia are subject to joint and several liability, which may mean that such a partnership structure may be unattractive.
The "net income" of a partnership is determined by deducting all the allowable deductions from the partnership's assessable income. Net capital gains and losses on partnership assets are ignored in working out the partnership's net income or loss; these gains and losses are brought into account by the partners themselves.
The partnership is not itself subject to tax on its "net income," rather, the net income is distributed to the partners in accordance with the partnership agreement and included in their respective income tax returns.
There is an increasing trend for cross border investments to take the form of hybrid investment vehicles. It may be desirable for instance to have a corporate tax structure in Australia and a partnership structure for the non-resident investor's domestic tax purposes.
An example of a hybrid investment vehicle is the limited partnership. In Australia, a limited partnership is a partnership where the liability of at least one of the partners is limited by virtue of the law under which the partnership is created, be that in Australia or elsewhere.
Subject to certain modifications, Australian income tax law deems a limited partnership to be a body corporate. The modifications deem all partners in a limited partnership to be shareholders, an interest in a corporate limited partnership to be equivalent to a share, and a distribution from a corporate limited partnership to be a dividend for Australian tax purposes. Thus, all the Australian income tax consequences of a company apply to the limited partnership, but the non-resident continues to treat the entity as a limited partnership in his home jurisdiction.
Companies are a common investment vehicle in Australia as they are able to retain profits for reinvestment and taxation is limited to a corporate tax rate of 30%. Profits earned by an Australian resident company may be remitted to a non-resident by way of dividends. Withholding tax applies to dividends paid to non-residents to the extent that the dividends are unfranked (i.e. paid out of untaxed profits). Franked dividends (i.e. paid out of tax-paid income) are not subject to withholding tax.
Australia has also introduced measures that ensure that Australian income tax and withholding taxes are not payable where an Australian resident company derives foreign income, and that foreign income is distributed either directly or through one or more further Australian corporate tax entities to non-residents. This measure was designed to reduce impediments for foreign investors who wish to structure their foreign investments through Australian companies instead of holding them directly.
If an overseas company (e.g. an Israeli company) carries on a business in Australia in its own right, it is obligated to register as a foreign company. A proportion of head office overheads can be attributed to branch operations and deducted from the branch's assessable income where this is reasonable. Income derived by a foreign company from its Australian branch is subject to tax at the rate of 30%. There is no branch profits tax or tax on the remittance of profits of the Australian branch of the company to its head office.
An Australian business that borrows from its non-resident investors is entitled to deduct interest payments from any Australian profits. In doing so, the Australian tax on profits repatriated to the investor as interest payments can often be limited to the 10% withholding tax. In contrast, dividend income sourced from taxed profits does not attract withholding tax, while dividend withholding tax of 30% applies if sourced from untaxed profits.
The tax bias toward debt funding is regulated by the thin capitalization provisions and the transfer pricing provisions. This is to prevent foreign investors from allocating excessive interest bearing, tax deductible debt to their Australian operations. The thin capitalization provisions apply to companies, trusts and partnerships.
In broad terms, the thin capitalization provisions provide that an investor into Australia will not be entitled to deduct interest payments in whole or in part, where the entity's average debt exceeds its maximum allowable debt. The maximum allowable debt is the greater of the safe harbor debt amount or the arm's length debt amount.
The safe harbor debt amount is essentially equal to 75% of the average value of the entity's assets for the income year. Where an entity's debt funding exceeds the safe harbor limit an adjustment to reduce the debt deductions will ordinarily occur, unless the entity demonstrates that the debt funding of the Australian operations would be acceptable under arm's length principles. The safe harbor debt to equity ratio may be exceeded where the funding may be commercially viable, in which case no interest deductions will be disallowed.
Repatriation of funds may also take the form of an advisory fee charged to the Australian operations. Providing the advisory fee is charged at a commercial rate and based on the level of services provided, it will be a deductible expense to the Australian operations. Furthermore, provided the payments are not regarded as royalties, withholding tax would not apply when the payment is made to a non-resident. However, the advisory fees will have an Australian source and be assessable to the non-resident under the normal assessing provisions.
As a general rule, Australian interest withholding tax is imposed on payments of interest by an Australian resident to Israeli residents. It is payable at a rate of 10% on the gross amount of interest paid or credited to a non-resident of Australia. The Australian resident paying the interest must withhold the correct amount of withholding tax.
Royalty withholding tax is imposed on payments of royalties by an Australian resident to Israeli residents at a rate of 30% of the gross royalty payment. There is an obligation on the Australian resident paying the royalty to withhold the withholding tax.
Capital Gains Tax (CGT)
The Australian Government recently introduced legislation that made major changes to the taxation of gains and losses on Australian assets owned by foreign residents. The legislation aligns Australia's taxation treatment with the practice of most OECD countries.
The Australian Government narrowed the range of assets on which foreign residents will be subject to CGT to: (1) Australian real property (2) direct and indirect disposal of Australian entities whose assets principally consist of Australian real property assets; rights or options in relation to Australian real estate assets are also covered by the legislation, (3) other assets used by foreign residents at any time in carrying on a business through a permanent establishment (branch) in Australia. In addition, revenue income from a business will be taxable as such - for example, a sale of homes by a builder.
The new position is that only foreign residents who together with their associates hold 10% or more interests in a company and its interposed entities (including foreign interposed entities), which have more than 50% of their value attributable to Australian real property will be subject to Australian capital gains tax on the disposal of those interests.
For example, a foreign resident may establish a foreign company that then invests in Australian real estate. The special rules ensure that the sale of the company by the foreign resident would be subject to Australian CGT consequences, in the same manner as the direct sale of the Australian real estate would. This ensures there is no tax anomaly between foreign residents who invest directly in Australia versus those who invest indirectly.
The legislation includes membership interests of less than 10% as being Australian real property interests if a greater than ten per cent interest in a company has been held throughout a 12 month period that began no earlier than 24 months before the disposal time and ended at the time of the disposal. This is designed to counter staggered sell downs. For example, if within the last year a foreign investor had a 100% interest in an entity and sold 93% of that interest, the remaining 7% would be subject to CGT if sold within the relevant 24-month period.
The law operates on an "all or nothing basis." If an entity's principal value relates to Australian real property, the entire gain from the sale of the shares will be subject to tax in Australia, regardless of what the remaining value relates to and whether or not it is Australian related.
The foreign resident will include the capital gain or loss in its overall calculation of Australian taxable income and will be taxed on an assessment basis at widely varying rates, according to whether the foreign investor is an individual, company.
How will Australian taxes interact with Israeli taxes for Israeli investors?
This will depend mainly on individual circumstances - see, for example, our article "Tax issues to consider when investing abroad" (The Jerusalem Post October 18, 2006). Key issues typically may include: the entity structure; the business model; intellectual property and research and development; finance aspects; income repatriation; exit strategy; management and employees; double tax relief; tax planning and anti-avoidance rules.
Israel does not have a tax treaty with Australia, but there are foreign tax credit rules in the domestic Israeli tax law. Subject to this, if an Israeli company with no permanent establishment (branch) in Australia simply trades from Israel with an unrelated Australian company, it should only pay tax in Israel. This is provided the Israeli company has no Australian sourced income.
If an Israeli company has a branch in Australian it will report the resulting profit or loss to the Israel Tax Authority as well as the Australian Taxation Office (ATO). Israel generally will tax the Israeli company on its worldwide profits, including Australian source profits, at the regular rate - 29% in 2007. However, there may be no Israeli company tax balance to pay after crediting Australian tax (30%) on Australian source profits.
Any excess foreign tax credit (30% Australian tax minus 29% Israeli tax equals 1% excess in this example) may be used in the following five tax years against other income of the same type from the same country (Australia).
If an Israeli resident company or individual invests in the shares of an active Australian business company, it may be able to defer Israeli tax until it receives a dividend from the Australian company.
As mentioned, if the dividends are fully franked (i.e. paid out of corporate profits taxed in Australia ) there will be no Australian withholding tax liability. Thereafter, the Israeli tax on such dividends would typically be: 20% for an Israeli resident individual investor holding under 10% of the Australian company, resulting in a combined tax burden of 44% in principle (= 30% Australian corporate tax plus 20% Israeli tax on the dividend of 70); or 25% for an Israeli resident individual holding 10% of the Australian company, or for an Israeli corporate investor, resulting in a combined tax burden of 47.5% in principle (= 30% Australian corporate tax plus 25% Israeli tax on the dividend of 70).
Alternatively, if an Israeli company (not individual) holds at least 25% in an Australian company, the Israeli company may choose to pay the regular rate of Israeli company tax (29% in 2007) on its share of the pre-tax profit of the Australian company and claim a credit for the 30% corporate tax paid in Australia - this should eliminate altogether the Israeli company tax, leaving a 30% combined tax burden.
Capital gains may be taxable in Israel notwithstanding the possible exemption in Australia (see above). For post 2002 gains, the tax rates are generally 20%-25% after Israeli inflation adjustment. For pre-2003 gains, the tax rates are generally 29% for Israeli companies, or up to 48% for Israeli individuals.
Israel's CFC (controlled foreign company) rules - aimed at taxing deemed dividends from passive overseas companies - should not apply as the 30% Australian corporate tax rate is over the 20% cap specified in the CFC rules for passive income.
Various other rules may apply. For example, an overseas company controlled and managed in Israel would be considered resident and fully taxable in Israel. In any event, Israeli investors must report the existence of their shareholdings in an overseas company in their annual tax return.
As always, consult experienced legal and tax advisors in each country in specific cases.
Leon Harris is an International Tax Partner at Ernst & Young, Israel. Jillian Saint is a tax specialist at Arnold Bloch Leibler, Lawyers and Advisers, Melbourne, Australia.