By KTA Team |

We frequently receive inquiries regarding the permanent establishment of foreign companies in Israel. The primary motivation behind these inquiries stems from the desire of foreign companies to undertake specific contracts in Israel while avoiding the implications of permanent establishment for taxation purposes. This article aims to provide an in-depth analysis of the various factors that the Israeli tax authorities take into consideration when determining a company’s residency status in Israel, as well as the associated tax liabilities within the country.

This article is intended to offer general information for consideration and does not provide specific tax advice to any company. We strongly recommend that clients consult with KTA in advance for guidance regarding any tax issues that may arise from operations in Israel.

General Consideration

According to the Israeli Tax Authority, there are certain criteria that determine whether a company that is incorporated abroad will be considered a resident of Israel for tax purposes. These criteria are outlined in the Income Tax Ordinance [New Version] 5721 – 1961. It is important to note that the determination of tax residency is a complex matter, and it is advisable to consult with an international taxation specialist for accurate advice tailored to specific circumstances.

The Israeli Tax Authority considers the following factors when determining the tax residency of a company incorporated abroad:

  1. Primary Place of Operation: If the company’s primary place of operation is in Israel, even if it is registered abroad, the Tax Authority may treat it as an Israeli resident company for tax purposes.
  2. Foreign Occupational Company: In certain cases, the Israeli Tax Authority may classify a foreign company as a “foreign occupational company.” This classification typically applies to companies that are registered abroad but carry out substantial activities or business in Israel. As a result, they may be subject to Israeli taxation.
  3. Controlled Foreign Company (CFC): The Israeli Tax Authority may also classify a foreign company as a “controlled foreign company” (CFC). This classification generally applies when an Israeli resident holds a significant level of control or ownership in a foreign company. The Tax Authority imposes specific rules and taxation on CFCs to prevent tax avoidance.

To clarify the tax residency status and relevant tax aspects for a company incorporated abroad, it is possible to engage in a “Pre-Ruling” procedure with the Israeli Tax Authority. This involves seeking a preliminary agreement that determines the company’s residency and provides clarity on tax obligations.

To ensure compliance with Israeli tax laws and optimize tax planning, it is recommended to consult with Kan-Tor & Acco who will in turn work closely with leading CPA firms with professionals who specialize in international taxation, who can provide guidance and assistance in reporting foreign companies in Israel.

Control and Management Tests for Overseas Incorporation

When a company is incorporated abroad, the Tax Authority conducts control and management tests to assess the company’s operations. These tests aim to determine the actual location of the company’s activities and decision-making processes, whether in Israel or a foreign country. The control and management test guidelines outlined in the 4/2002 regulations state that, in cases where a double tax treaty (DTT) exists between the relevant countries, the legal ownership alone is not sufficient to establish the residency of a company. Instead, the focus is on the effective management of the company, including:

  • Location of the decision-making process
  • Location of the director’s activities
  • Location of the person responsible for making decisions or the officer
  • Governing language
  • Location of production, customer meetings, and other activities
  • Location of the company’s ledgers
  • Location of employees
  • Location of the company’s offices and assets
  • Location of various consultants and service providers
  • Place where the company submits reports to authorities
  • Residency of the actual controlling shareholders of the company

Management contracts with external parties, such as management companies, should also be examined as part of the control and management assessment. If the answers to the above questions indicate that the company’s effective management occurs in Israel, the Tax Authority will recognize the company as a resident of Israel for tax purposes.

Permanent Establishment in Israel

According to the law, if a company with a permanent establishment in Israel has foreign residency, it will be subject to taxation in Israel. This applies when there is a trade relationship between the foreign resident company and related entities in Israel, resulting in revenue from that activity. Additionally, a foreign corporation providing services to Israeli residents will be liable for income tax if the services are produced in Israel.

If the foreign corporation is a resident of a country that has a double taxation treaty (DTT) with Israel, it will be taxed in Israel only if it has a “permanent establishment.” A permanent establishment is defined as a fixed place of business through which the enterprise conducts its business or when its activities in Israel are carried out through an authorized agent entering into contracts on its behalf.

Considering the changes from a traditional to a digital economy, the 2016 Income Tax Circular clarifies that a permanent establishment can exist in Israel when the foreign corporation’s economic activity is predominantly conducted through the internet. Additional conditions must be met, including the involvement of representatives in locating Israeli customers, collecting information, managing customer relations, and adapting services to Israeli customers.

Business activities that meet the requirements of the permanent establishment test subject the foreign resident (owner of the permanent establishment) to reporting and taxation obligations in the country where the business is conducted. If income is generated through a permanent establishment, the country of origin has primary taxation rights over business profits, while the country of residence has residual taxation rights.

Determining Controlled Foreign Company (CFC) Status

Section 75(b)(1) of the Income Tax Ordinance stipulates that a controlling shareholder of a controlled foreign company with unpaid profits is deemed to have received a dividend equivalent to their share of the profits. The Tax Authority identifies a company as a controlled foreign company if the following conditions are met:

  • The company is incorporated abroad.
  • It is held by a controlling shareholder.
  • Its rights are not listed for trading on the Tel Aviv stock exchange (TA SE).
  • It accumulates unpaid profits subject to a tax rate in the country of origin not exceeding 15%.
  • The tax rate on dividends does not exceed 15%.
  • Most of the revenue is passive.
  • Over 50% of the company is held by an Israeli resident with decision-making authority.

Determining Foreign Occupational Company Status

The Israel Tax Authority has the authority to tax the international revenues of a foreign company if it is classified as a foreign occupational company. According to Section 75b1 of the Tax Ordinance, a foreign occupational company is a foreign resident company with over 75% of its shareholders being Israeli residents. Its income derives from a “special occupation” designated by the Minister of Finance, subject to approval by the Knesset Finance Committee.

List of conditions:

  1. A foreign resident company;
  2. Controlled by up to 5 people;
  3. 75% or more of one or more of the means of control in it are directly or indirectly held by Israel residents;
  4. The controlling shareholders who hold 50% or more are engaged in the special occupation;
  5. Most of the company’s revenue or profits in a fiscal tax year comes from the special occupation;
  6. The special occupation is which of the following categories:

security; agronomy; architecture; arts and crafts, including art creation; promotion, acting; singing and entertainment; Astrology, graphology and the occult; criticism including quality and quality criticism; modeling; teaching, guidance, training, including giving lectures; engineering; veterinary medicine; creating computer hardware, operating computer hardware and handling computer hardware; computer programming; investigations; aviation and sailing; telecommunications; Representation of a specialist; consulting, including in the financial, personal, security, agricultural, technical, engineering, organizational, administrative, political, scientific, taxation, business, economic fields; economics; writing and composing; scientific research and development; Management, including management of portfolios, investments or assets, management of companies, management of organizations, institutions, commercial entities including in liquidation, bankruptcy or assembly proceedings Properties; Statistics; Sports; Journalism and Editing; Advertising and public relations; law practice, drafting patents, representation before judicial tribunals; Photo; Accounting; medicine, psychology, physical therapy, dentistry, providing medical and paramedical services, alternative medicine, treatment of developmental disabilities; religious services; appraisals; mediation; translation; communication, staging, production and editing.

7. Unpaid accumulated profits