A major advantage of a family company is protection for Israeli investors from foreign estate taxes on investments in the US, UK, Canada, etc.
By LEON HARRIStaxes good 88(photo credit: )
A useful investment vehicle in the Israeli tax law is the "family company" (hevra mishpahtit). Legally speaking, a family company is a company like any other, accompanied with the usual limited liability. However, for Israeli tax purposes, the company is ignored; instead, the main shareholder is taxed as if he or she derived the company's income directly. This is definitely having your cake and eating it too; the company protects you but isn't taxed in Israel.
Readers from the US will note this is similar to a Subchapter S corporation or an LLC (limited liability company), but not identical. Unlike the situation in the US, only the main shareholder of a family company is taxed in Israel, and not all the shareholders on a prorated basis to their ownership stakes. There is no comparable concept in the UK, Canada or most other countries.
What are the main advantages?
First, lower overall taxes in Israel, especially on investments in certain circumstances. For example, in 2008 a regular company pays company tax of 27 percent, and dividends paid to shareholders holding 10% or more of any means of control are subject to a withholding tax of 25%, resulting in a combined Israeli tax burden of 45.25%.
By contrast, total Israeli taxes on investment income derived via a family company may only be as follows: dividends are taxed at 15%-25% of capital gains from publicly traded securities; interest is taxed at 20% in most cases (47% for 10% shareholders and certain other cases). Additionally, 10% of gross rents may be elected if the tax is paid within 30 days after the tax year-end (other possibilities exist).
Meanwhile, for foreign rental income, 15% of gross rental income minus depreciation for Israeli tax purposes may be elected (again, other possibilities exist).
Foreign shareholders should also check their tax in their home country, including any double tax relief (e.g. foreign tax credit or exemption).
A second major advantage of a family company is protection for Israeli investors from foreign estate or inheritance taxes on investments in the US (up to 45%), UK (40%), Canada (24%), etc. For example, an Israeli individual investor in US real estate or most US securities exceeding $60,000 in total is exposed to US estate tax if the individual dies - even if that person was not a US citizen, green-card holder or resident. US financial institutions have been known to freeze the client's account until the tax is paid. By contrast, most non-US companies are generally exempt from US estate tax, including Israeli family companies.
What are the main conditions?
Briefly, they are as follows: All members (shareholders) are from one family, with family being defined as spouse, brother, sister, parent, grandparent, offspring, spouse's offspring, and spouse of each of these. For an existing company, family-company status is elected on Form 2585 Aleph at least one month before the beginning of the first year in which it will apply. So if you want family-company status to begin in 2009, file your election with the tax authority by November 30, 2008.
For a new company, family-company status may be elected within three months after incorporation.
As indicated above, income and losses of the family company are treated for Israeli tax purposes as income or losses of the member (shareholder) who is entitled to the largest or joint largest share of profits of the company.
Distributions out of family-company income are disregarded and not taxed again.
Monthly tax installments (mikdamot) remain payable by the family company on account of the taxpayer's tax.
National Insurance contributions remain payable and the income of the family company is deemed to be distributed to its shareholders on the last day of the tax year.
Losses derived by the taxpayer from other sources before company status began cannot be offset against family-company income.
Regular Israeli bookkeeping and reporting requirements will apply to the family company and an annual audit will be necessary.
Initial and annual fees of the Companies Registry remain applicable, as well as a capitalization fee of up to 1% of newly registered capital.
Upon any sale of shares of the family company, retained profits derived by a family company are excluded from the taxable consideration; this applies to both the seller and the purchaser.
A company may stop being a family company by no longer complying with the conditions or by notifying the Israel Tax Authority by the due date for filing its tax return (usually May 31). The company cannot become a family company again until three tax years after the end of the year in which the company stopped being a family company.
According to a recently published tax ruling, a family company can be a foreign company, not only an Israeli company.
What changes are in store?
In 2003, an amendment was passed allowing family companies to be replaced by "transparent companies" if and when regulations in this regard are issued. According to the amendment, the income of a transparent company is allocated on a prorated basis to all shareholders, not only the largest. Also, all shareholders of a transparent company must be Israeli residents. However, we are still waiting for these regulations and do not expect them to be issued anytime soon.
Other alternatives to a family company exist under which investors are taxed instead of the entity, even if the investors are not from a single family. These alternatives include limited partnerships and house companies. Each of these vehicles have pros and cons.
As always, consult experienced tax and legal advisers in each country at an early stage in specific cases.
leonharr@gmail.comLeon Harris is an international tax specialist.
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