The UK and Israeli governments signed a protocol to amend the income tax treaty between the two countries after Parliamentary and Knesset ratification, expected in around a year. The original treaty, dating back to 1962, was last amended in 1970.
The newest amendment will be of interest to UK olim, investors and companies based in one country with interests in the other. Unlike an earlier proposal, the amended treaty will continue to define Israel as “the territory in which the Government of Israel levy taxation”.
If a person other than an individual (i.e. a company or a trust) is dual resident under the laws of each country, the tax authorities of the two countries shall “determine” the country of residence for treaty purposes, having regard to its place of effective management, the place of incorporation “and any other factors” (not defined). This is likely to be bureaucratic.
Prior to the amendment, the place of effective management was the country of residence, with no need to ask the tax authorities to “determine” this.
Under the amended treaty, a company from one country may have a taxable term permanent establishment (fixed place of business) in the other country if any combination of activities such as storage are not of a preparatory or auxiliary character.
In practice, this means local income tax for online suppliers that uses local warehouses e.g. if a UK clothing store sells clothes over the Internet to Israeli residents if the clothes pass through a warehouse or fulfillment house in Israel.
Under the amended treaty, if a tax authority makes a transfer pricing adjustment, the other country shall generally make a corresponding adjustment but the two tax authorities may consult each other if necessary.
Under the amended treaty, dividends paid by an Israeli company may be subject to a 5% withholding tax if paid to a UK parent company holding at least 10% of the Israeli payor company in the 365 days ending on the dividend payment date. Otherwise the old 15% dividend withholding tax rate applies. In practice, the UK does not withhold tax from dividends paid by UK companies. Special rules are prescribed for real estate investment trusts.
As for interest payments, the old 15% withholding tax rate will be replaced by 0% (payments to a governmental body pension scheme and on publicly traded bonds), 5% (on bank loans) and 10% in other cases. The recipient may elect to pay corporation tax (23% in Israel, 19% in the UK) on the interest spread after the end of the taxable period, i.e. pay and reclaim any excess withholding tax – bureaucratic.
Royalties will continue to enjoy a withholding tax exemption. An exception whereby 15% of film royalties were taxed at the corporation tax rate will be dropped.
Tax imposed under the Petroleum Profits Law 2011 (the Sheshinski tax) is covered by the treaty. This may enable UK investors in Israeli gas to credit this tax against UK tax.
Pensions and other similar remuneration paid to an individual resident in one of the two countries will be taxable only in that country, once the amended treaty is effective. Until the amended treaty is effective, olim from the UK in their tax year tax holiday must choose between UK or Israeli tax on their UK pensions.
Double tax relief
Both countries will continue to grant a foreign tax credit, subject to certain anti-avoidance limitations, except where UK law allows a “participation exemption” for dividends from an Israeli company.
But the amended treaty will repeal “tax sparing” relief whereby UK residents received enlarged foreign tax credits to the extent of tax saved in Israel (tax incentives for approved properties and certain enterprises) under the Encouragement of Capital Investments Law, 1959. Such “tax sparing” was a relic of UK colonial policy.
Under the amended treaty, aggrieved residents may present their case to either tax authority for review and possible mutual agreement within three years after the “tax action” concerned.
Under the amended treaty, there is a new OECD-inspired clause allowing the tax authorities to deny treaty benefits if they conclude that obtaining such a benefit was a principal purpose of the arrangement or transaction. This may perhaps prevent “treaty shopping” using UK holding companies.
The amendment for pensions from the UK is welcome as it will put UK olim on a similar footing to olim with pensions from other countries. The reduction in withholding rates on certain dividends and interest will also be beneficial.
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. at Harris Consulting & Tax Ltd. He can be reached at email@example.com.