The proposed great international tax reform – Part 2, companies - opinion

Below we mainly review proposed proposals for companies (mainly). Last week we reviewed proposals for individuals and immigrants.

Calculating taxes (photo credit: INGIMAGE)
Calculating taxes
(photo credit: INGIMAGE)

On November 21, the Israeli Tax Authority published a report proposing to reform international taxation rules.

Unfortunately, the proposals are detailed and mainly involve bureaucratic requirements, in case there was any for tax planning. Revenue raising under the OECD twin pillar package is not featured.

Below we mainly review proposed proposals for companies (mainly). Last week we reviewed proposals for individuals and immigrants.

It remains to be seen what will be legislated and when.

FOREIGN TAX CREDITS

Illustrative photo of Israeli money (credit: MARC ISRAEL SELLEM)Illustrative photo of Israeli money (credit: MARC ISRAEL SELLEM)

An Israeli resident company or individual can only credit foreign tax against Israeli tax on the same type or “basket” of income or gain. Currently, there are 11-12 baskets. It is proposed to reduce this to five baskets: passive income, active income, capital gains, controlled foreign companies (CFCs) and foreign professional companies.

If a US citizen residing in Israel derives income from a third country, say the UK, it is proposed to deny a credit for the third country (UK) tax in Israel if a credit is also claimed in the US.

COMMENT

This ignores the fact that third country income may be taxed in both the US and Israel. This proposal would also affect credits for foreign tax paid by Israeli groups.

Before claiming a foreign tax credit for tax paid to a country that lacks a tax treaty with Israel, advance permission would be needed from the Israel Tax Authority (ITA).

Currently, excess foreign tax credits can be carried forward up to five years. It is proposed to stop carrying forward excess foreign tax credits unless they result from losses in Israel or timing differences.

Currently, Israeli resident companies can credit not only foreign dividend withholding tax but also corporate income tax paid by 25%-or-more affiliates (“daughters”) or their 50%-or-more subsidiaries (“granddaughters”). It is proposed to also allow a credit for 50%-or-more subsidiaries of the latter (“great granddaughters”). But any credit would only be allowed if the dividend payor is owned at least 12 months and the dividend is derived from third party income.

CONTROLLED FOREIGN COMPANIES

Currently, Israel generally taxes undistributed income of 10%-or-more Israeli resident shareholders of companies that derive mainly passive revenues or profits, pay 15% or less tax thereon and are over 50% owned by Israeli residents.

The report proposes to make passive revenue include: (a) insurance income from related parties; (b) royalties from related parties if the company can bear “essential risks” or relating to purchased intangible assets; (c) interest from related parties, if the payor would otherwise escape CFC taxation or is an Israeli resident including permanent establishment abroad or the Israeli company gave a loan note not bearing interest under transfer pricing rules or bearing untaxed interest; (d) “benefits” from financial assets; (e) “profit shifting” to a company unable to bear related risks; (f) capital gains from intangible assets owned over one year, but this may be rebuttable under rules the ITA Director would set.

It is proposed that tougher CFC rules would apply to countries on gray or black lists, including the Netherlands, Finland and Sweden, in particular: a 30% Israeli shareholder threshold; a 33.3% share of revenues or profits.

It is proposed that immigrants in their 10-year tax holiday would count as Israeli residents but they would not themselves pay CFC taxation.

It is proposed to empower the ITA Director to over-rule CFC taxation in a reorganization.

FOREIGN INVESTORS IN ISRAELI REAL ESTATE COMPANIES

Foreign investors enjoy an Israeli capital gains tax exemption when selling securities in Israeli companies that do not mainly hold Israeli real estate. The report proposes making the no-Israeli-real-estate rule apply throughout the three years prior to sale.

NO PERMANENT ESTABLISHMENT

The report contains a (strange) proposal to tax a foreign resident operating in Israel without a permanent establishment (undefined) if interest, royalty or pension costs are deducted.

US LIMITED LIABILITY COMPANY

Currently, Tax Circular 5/2004 allows an LLC shareholder (member) to credit US tax against Israeli tax. The report proposes allowing the shareholder set off US losses between all LLCs, S-Corporations and partnerships held by the taxpayer.

HYBRID FINANCE

Based on Action 2 of the OECD measures against BEPS (Base Erosion and Profit Shifting), the report proposes a string of measures aimed at preventing cross border interest payments being deducted as an expense in one country without being taxed in another country. 

These measures would target hybrid entities (transparent in one country not the other), reverse hybrid entities (the reverse) and hybrid instruments (debt in one country, equity in the other).

As always, consult experienced tax advisers in each country at an early stage in specific cases. [email protected] The writer is a certified public accountant and tax specialist at Harris Horoviz Consulting & Tax Ltd,