Important Tax Issues for Companies with U.S. and Israeli Operations
Insight September 17, 2009
If you are a company with operations in both the United States and Israel, you should be aware of several very important U.S. and Israeli Tax issues when you engage in cross border operations. I have set forth below several of the main issues. This list is not exhaustive and only reflects briefly the main tax issues. Other issues such as employment, banking, intellectual property rights, custom duties etc. will be addressed in other communications.
A. U.S. TAX ISSUES
1. U.S. Distributor
The use of a distributor or agent should not subject the Israeli company to U.S. tax unless such business is conducted through a so-called permanent establishment.
Whether a distributor is deemed to be a permanent establishment for the Israeli company in the United States should be examined under domestic U.S law and under the U.S./Israel Income Tax Treaty.
In general, a U.S. distributor can be deemed to be a permanent establishment of a foreign entity if it is not independent of the foreign entity and/or can sign contracts on behalf of the foreign entity.
2. Sales and Use Tax
A U.S. entity of an Israeli company may have to charge sales tax to its customers if it has nexus where it is located. Nexus can be created if a business maintains a presence of people or property in a given jurisdiction. Sales tax rates and exemptions differ per state.
3. Tax Administration
A U.S entity will be subject to filing different tax returns such as federal tax returns (Form 1120: U.S. corporate income tax return) and state tax returns (e.g., Form 100: California Corporation Franchise or Income Tax Return). If doing business in several states, the U.S. entity might have to file in different jurisdictions.
4. Foreign Tax Credits
If a U.S. company earns income in Israel, that income is taxable in the United States and may be taxable in Israel as well. Therefore the United States allows the U.S. company to offset taxes due in the United States with the income taxes paid in Israel. However, since the United States only provides a foreign tax credit for foreign income taxes imposed on what the United States considers to be foreign source income, the U.S. sourcing rules are very important and require the U.S. company to maximize the foreign source income to allow a maximum foreign tax credit
5. Foreign Currency Transactions
The U.S. Tax code has several sets of rules for the treatment of gains and losses arising out of currency transactions, which can arise (e.g., as a result of the acquisition and disposition of foreign currency, lending and borrowing of foreign currency and foreign transactions).
B. ISRAELI TAX ISSUES
1. Grants, Tax and R&D Incentives
The Law for Encouragement of Capital Investment features two types of benefits. The first is a package of grants and tax reductions, administered by the Investment Center at the Ministry of Industry, Trade and Employment. The second is the Automatic Tax Benefits Program administered by the Tax Authority.
There are several conditions in order to qualify for the grants and tax reductions. The scale of benefits depends on the location and size of the investment.
The Office of the Chief Scientist (OCS) is responsible for promoting industrial research and development. There are various incentive schemes available through the OCS.
2. Corporate Taxation
A corporation will be deemed to be resident in Israel if its activities are managed and controlled from Israel or if it is organized under the laws of the State of Israel. The basic rate of company tax is 26% in 2009, to be reduced to 25% as from 2010 and onwards. A recent proposal under the 2009-2020 Israeli Budget even calls for reducing the company tax rate to 18% by 2016.
Business losses may be offset against income from any source in the same year. Losses may be carried forward indefinitely from one income year to another but may not be carried back.
3. Value added tax (VAT)
VAT applies to most goods and services, including imported goods and services and is levied at the rate of 16.5% Certain items are zero-rated, including exported goods and the provision of certain services to nonresidents.
C. MUTUAL TAX ISSUES
1. Withholding Taxes
When an Israeli company remits dividend, royalty or interest payments to a U.S. party (or vice versa), these payments are subject to a withholding tax as set forth in the U.S./Israel Income Tax Treaty (the “Treaty”). Under the Treaty, the maximum withholding tax on these payments is 25% for dividends, 15% for royalties and 17.5% for interest payments.
2. Intercompany Transactions
The IRS scrutinizes intercompany or related parties transactions (e.g., transactions between U.S. headquarters and Israeli subsidiary) to ensure that the parties conducted the transaction at arm’s length and that the related parties did not set prices at artificial levels in order to avoid the tax that would have been due had unrelated parties negotiated the price.
The IRS has published guidelines for evaluating whether or not a transaction between related parties was conducted at arm’s length. These guidelines provide a number of methods depending on the type of business and products sold.
The Israeli transfer pricing rules are based on the OECD guidelines. Several pricing methodologies apply, with preference given to transaction-based methods over profit-based methods.
Rimon Law Group is well positioned to assist you and your clients with cross border tax issues, especially between the U.S. and Israel as a result. Our attorneys have extensive experience and expertise in international tax and cross-border transactions. Every attorney in our Israel Practice Group is licensed to practice in both the United States and in Israel, is fluent in both Hebrew and English, and has at least ten years of experience at top U.S. and Israeli law firms and companies.
If you have any questions about international tax issues you can contact Dave Wolf, Esq. at Dave.Wolf@rimonlaw.com. To discuss Rimon’s Israel practice group, you can contact Michael Moradzadeh, Esq. at Michael@rimonlaw.com.
Circular 230 Disclaimer: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or tax-related matter(s) addressed herein.