Your Taxes: Intercompany loans ease global trade for Israeli firms

They say money makes the world go round. Even the Israeli Tax Authority has cottoned on to this.

taxes good 88 (photo credit: )
taxes good 88
(photo credit: )
They say money makes the world go round. Even the Israeli Tax Authority has cottoned on to this. Since the Israeli population and marketplace is relatively small, Israel has become a major high-tech exporting country. Most international trade takes place between related companies. This is because customers in each country usually prefer to buy products from local companies even if they are subsidiaries of Israeli companies (or other multinational groups). But local subsidiaries don't pay straight away for the products they buy from their Israeli affiliates - they need credit until their customers pay them - and they may plough money back into trade exhibitions and other marketing expenses. So, international trade is facilitated by "intercompany" loans, including suppliers' credit and many billions of dollars are involved in Israel alone. What is the Israeli tax treatment of intercompany loans between related companies? We are still waiting to hear. In January 2007, Israel introduced transfer pricing legislation which requires international transactions between related parties to be on "arm's length" market terms. This applies to all types of intercompany goods, services and credit transactions. But is an arm's length rate of interest calculated on the shekel loan amount or the foreign currency loan amount? And what if foreign currency fluctuations change the amount owing? Between January 2007 and March 2008, things were muddled causing much heartache for many Israeli multinational companies and their auditors and tax advisors. Then in March 2008, the Israeli Tax Authority published a clarification that the transfer pricing rules won't apply to interest on certain loan notes (known in Israel as "capital notes") issued to Israeli companies by their foreign affiliates to finance activities in 2007. Proposed legislation Early in 2009, the Israeli Tax Authority published another announcement. The Tax Authority intends to recommend to the Finance Ministry to amend the transfer pricing rules to say that loan notes and bonds issued by another entity up to the end of 2008 will not be regarded as credit if: (1) they do not bear interest or linkage differences, and (2) in the case of loan notes linked to a foreign currency, annual interest does not exceed the the exchange rate movement. In addition, the Israeli Tax Authority will not apply minimum interest provisions in Section 3(j) ("shalosh yud") of the Income Tax Ordinance to international credit transactions. The proposed legislation is expected to include transitional provisions that would enable the terms of loan notes issued before the commencement date of the new legislation to be adapted. The Israel Tax Authority says it will act on the basis of the above proposals while they are being enacted or until the end of 2009, whichever is first. As always, consult experienced professional advisers in each country at an early stage in specific cases. leonharr@gmail.com The author is an international tax specialist.