The Israel Tax Authority (ITA) has just published a battery of anonymous rulings regarding the interaction between US and Israeli taxes. These are important when seeking to avoid double taxation.
The rulings matter if you are a US citizen or resident or an Israeli resident with US interests. And if you think a US LLC (limited liability company) is okay, read on.
US LLC and Israeli exit tax
In 2005, an Israeli citizen and resident acquired over 30% in a US LLC engaged in business in the US. In 2009, he and his family became US residents. In 2020, he sold around 80% of his LLC holding. The LLC was a transparent “flow-through” entity for US tax purposes, meaning the taxes were on the LLC owners, not the LLC itself.
Israel imposes an exit tax, really a capital-gains tax, of up to 33% on Israeli-resident individuals who stop residing in Israel. The exit-tax liability arises on the day before departure from Israel, but the individual may choose to pay it when selling the asset on the predeparture portion of the gain. The question here is whether US taxes on the actual sale qualify for a foreign tax credit against the Israeli exit tax?
Tax Ruling 8808/22 said no: The ITA will NOT allow a foreign tax credit for the US tax. This is because a flow-through LLC is not considered US resident according to the US-Israel tax treaty. Moreover, the ITA says US law does not contain any provision allowing the US to tax the individual when the Israeli exit-tax liability first arose the day before departure from Israel. The ruling also says the ITA intends to negotiate the matter with the IRS, and if no agreement is reached, the ITA will apply a mechanism for dealing with double taxation.
Comment: The ruling does not spell out the mechanism. This perpetuates uncertainty. The taxpayer should have considered alternative action at the outset.
US LLC in an Israeli M&A deal
In another ruling (5559/22), a US-resident corporation acquired an Israeli resident via a subsidiary LLC, and the two US entities filed consolidated US tax returns. The question was whether the LLC qualified for benefits under the US-Israel tax treaty. Unlike the above case (ruling 8808/22), the ITA ruled that the LLC did qualify for treaty benefits because the LLC had filed an election with the US to be opaque (not a transparent flow-through) for US tax purposes.
Big sting for Israeli-resident CEO who is also a US citizen
In Tax Ruling 2007/22, Mr. A is a busy jet-setting Israeli resident and US citizen. He works in Israel and the US as president and CEO of a publicly traded group with a US-resident parent corporation and an Israeli-resident subsidiary. He receives all his salary from the Israeli subsidiary, but a portion of the salary cost is re-charged to the US parent pro rata to days worked in the US.
The Israel subsidiary withholds US taxes from the salary regarding days worked in the US, as required by US law. The Israeli subsidiary also withholds Israeli tax, apparently from worldwide salary. The question was whether a foreign tax credit is allowed in Israel for days worked in the US?
The ruling decision starts off okay. It allows a foreign tax credit subject to limitations, but not exceeding the Israeli tax and not to the extent expense deductions are claimed under Israeli tax regulations. Deductions are available for accommodation, child education, health care and flights. There is also a per diem meal allowance if the employer is not Israeli resident.
But there is a sting in the tail. The individual’s employment package includes securities, presumably stock options or restricted stock units (RSUs). The ruling says US tax on securities would not qualify for a foreign tax credit in Israel if imposed merely because the individual is a US citizen.
Comment: This is a coded message. Under the US-Israel treaty, Israel gets a first right to tax securities in a US corporation of an Israeli resident holding under 10% of the voting power throughout the year preceding a sale. This means no foreign tax credit for US tax on such securities’ gains. This is notwithstanding a “saving clause” in the US-Israel tax treaty allowing the US to keep taxing US citizens.
Israeli residents should treat LLCs with extreme caution. And if you are a jet-setter, check your taxability and foreign tax-credit rights in each country concerned, not only in Israel.
As always, consult experienced tax advisers in each country at an early stage in specific cases. The writer is a certified public accountant and tax specialist at Harris Horoviz Consulting & Tax Ltd.