Telecommuters are people who live and work in Israel for a company based abroad that is not registered in Israel. This is now easy thanks to e-mail, the Internet and cheap videoconferencing. But there can be a number of tax implications for the individual and the company, in Israel and abroad. Why? Let's suppose you are resident in Israel and employed by a New York-based software corporation called ABCD Inc. One day you supply services worth $100 and the resulting software product is supplied to a California customer for $1,000. The Israel Tax Authority will want to tax your $100 and perhaps also the $900 profit of ABCD Inc. This is because Israel tax treaties with the US and other countries let Israel tax the Israeli source profits of a "permanent establishment" in Israel. A permanent establishment is any "fixed place of business" or branch - even a room in your home, or a "dependent agent" - such as an employee. In other words, ABDC Inc. is doing business in Israel through you and it must pay the 27 percent Israeli company tax on Israeli source profits you generate, among other things. This may not be what ABCD Inc. bargained for even if the tax is creditable abroad. The same issues occur in the US or elsewhere when an Israeli hi-tech start-up hires a few employees in a foreign country. Given this, what are the options? There are at least four: â€¢ You become a self-employed (independent) contractor of ABCD Inc.; â€¢ You set up your own company which contracts with ABCD Inc.; â€¢ ABCD Inc. opens a branch office in Israel and employs you; â€¢ ABCD Inc. opens a subsidiary company in Israel and employs you. Each of these scenarios has its pros and cons. If you became a self-employed independent contractor This implies you may also have other customers (otherwise ABCD Inc. may still be exposed to Israeli tax). You will presumably not enjoy the legal benefits of being an employee, such as vacation or severance pay. But check this with a lawyer. Self-employed contractors pay income tax at rates ranging up to 47% (in 2008) and social security (National Insurance Institute) payments at graduated rates ranging up to 16.05% on the first NIS 36,760 of income per month. However, the impact is mitigated as 52% of social security payments by a self-employed contractor are deductible for income tax purposes in the year they are paid, resulting in a net effective rate of around 13%. Other expenses incurred wholly and exclusively in the production of taxable income are also deductible, subject to detailed rules for some items such as travel and entertainment expenses. You will be required to keep accounting records on software approved by the Israel Tax Authority. Upon starting up you will need to register for Israeli income tax, social security and VAT purposes. You will then be asked to pay tax and VAT installments, usually by the 15th day after each month-end (possibly bimonthly in smaller cases). The Israeli tax year is the calendar year. You will be required to file annual tax returns by April 30 if you keep "single entry" accounting records, or May 31 if you keep "double entry" accounting records. However, extensions are obtainable, particularly if you hire an accountant who participates in an arrangement of the Tax Authority's to spread the filing of clientele tax returns over a period of up to 13 months after the year-end. Self-employed contractors and company owners are periodically asked to file capital returns of all their personal assets. This is an enforcement measure as there is no annual wealth tax in Israel nor is there an estate or inheritance tax (only capital gains tax when assets are sold). There may also be a 15.5% VAT liability on your billings to ABCD Inc.; this applies if your services relate to assets in Israel or residents of Israel or foreign residents in Israel or an agreement involving an Israeli resident party (among others). If you are a US citizen or a non-Israeli resident, you will have to claim a foreign tax credit for Israeli tax on Israeli source profits against taxes in the other country - Israel gets "first bite of the tax cherry." US citizens can also claim an "exclusion" (exemption) from US federal tax on Israeli source earned income up to certain amounts if various conditions are met. Please consult your US CPA. If you set up your own Israeli corporation The corporation could provide services in Israel to ABCD Inc. It will generally be subject to company tax at 27% on its profits. As the main shareholder, you will also pay 25% tax, generally, on dividends received from the corporation. If you use a non-Israeli corporation formed before you become an Israeli resident, special rules may enable you to claim an exemption for new residents for five years. If the corporation pays you salary (and perhaps bonuses), tax will be withheld at source at graduated rates ranging up to 47%. Social security will also be payable on the first NIS 36,760 per month at rates ranging up to 12% (employee's contribution) and 5.43% (employer contribution). Alternatively, you may file an election for your corporation to be treated as a "family company" if it is owned by members of one family and the election is filed within three months after its incorporation - or by November 30 for the election to commence in the following tax year. If you elect "family company" status it is not taxed; instead the largest shareholder is taxed at individual tax rates (up to 47%, etc). Social security will also apply at various rates applicable to dividends even if no dividend is actually paid. Other monthly and annual accounting and reporting requirements also apply to all corporations (see above) and an annual audit is also needed. If you are an employee of ABCD Inc. or its Israeli subsidiary Tax and social security will be withheld at source from your salary. As mentioned, the company tax rate in Israel for corporations doing business in Israel is currently 27%. There will also be VAT and reporting obligations and a need to establish a reasonable business model and arm's length "transfer pricing" between the Israeli office and the group abroad. Dividends to a foreign parent corporation will be subject to a 25% withholding tax unless reduced by any tax treaty - for example 12.5% to regular US parent corporations. There may also be VAT on billings. The above is only a brief summary and many additional considerations may be relevant. As always, consult experienced lawyers and tax advisors in each country at an early stage in specific cases. firstname.lastname@example.org Leon Harris is an international tax partner at Ernst & Young Israel.