14.09.2010

Israel is like riding a bicycle: you get used to it.

The World Bank‘s Web site has a comparison of various aspects of doing business in 183 countries in 2010. Israel scores quite well: No. 5 for protecting investors; No. 4 for getting credit; No. 11 for trading across borders; No. 34 for starting a business; No. 29 overall.

So what are the main factors to plan when starting a business in Israel? You should check this out with professional advisors in each country, but the items on your agenda will probably include the following:

  Do you need a company in Israel?
  If so, should it be a subsidiary or a branch of a non-Israeli company?
  How to incorporate in Israel and register for tax purposes?
  What monthly and annual tax filings are needed?
How much tax will there be on profits?
  How to repatriate income?
  What about any future exit?

Do you need a company in Israel?

For most businesses, a company is the preferred way of doing business.

A company generally has limited liability, which means it can be sued to the extent of its capital and resources, but its shareholders generally cannot lose more than their investment in the company if they acted in good faith.

Other possibilities include being self-employed, forming a partnership or even a limited partnership under Israeli or foreign law.

Limited partnerships tend to be used mainly as passive investment fund vehicles to enable a group of foreign individual investors to credit Israeli taxes (or utilize any Israeli losses) for tax purposes in their home country.

If you decide on a company, should it be a subsidiary of a non- Israeli company? In the past, many Israeli hi-tech companies were formed as subsidiaries of a United States (or other foreign) parent corporation.

This was done mainly to avoid Israeli capital-gains tax upon any exit at rates of up to 50 percent.

All this has now changed, and Israel offers passive foreign investors exemption from capital-gains tax in most cases upon exit (see below).

Furthermore, the use of a US parent corporation is particularly problematic because the US may tax undistributed profits under complex provisions in the US Internal Revenue Code (Subpart F).

To sum up, an Israeli parent company is usually fine from the tax perspective and can readily be taken public on stock exchanges in the US, London, Toronto and elsewhere after meeting their normal listing requirements. And an Israeli company may enjoy tax breaks on its profits (see below).

It is possible to operate a business operation in Israel as a branch of a foreign corporation. In this way, it may be possible to avoid dividend withholding tax (up to 25%) in most cases, but company tax (see below) will still be payable on Israeli source profits.

In practice, the Israel Tax Authority (ITA) may request to see the overseas accounting records of the foreign corporation to check how much income and expenses are allocatable to its Israeli branch for company tax purposes. And a foreign company is not exempt from the Israeli statutory audit requirement.

US investors occasionally use US LLCs (limited liability companies) with no other activity to conduct Israeli operations that do not qualify for Israeli tax breaks.

In practice, most Israeli business operations are conducted by an Israeli company. This is usually easier when dealing with Israeli suppliers, customers and banks.

How do you incorporate in Israel and register for tax purposes?

An Israeli lawyer is needed to help incorporate a company in Israel. The Israeli Companies Law, 1999, largely follows UK and US principles. Companies may be public or private.

A private company must have at least one shareholder and one director.

The issued share capital can be as little as one shekel (26 US cents).

A public company is a company whose shares are traded on a stock exchange (in Israel or abroad) or have been offered to the public pursuant to a prospectus under the Securities Law and are held by the public.

It usually takes a day or two to incorporate an Israeli company. A foreign company must be registered at the Israel Companies Registry as a foreign company if it has a place of business or an office for share transfers in Israel.

Separate registrations of a new business in Israel are needed for the purposes of: (1) income tax; (2) value-added tax (VAT); (3) payroll and other withholding taxes; (4) National Insurance Institute payments (social security). Such registrations should be done at the local offices of the respective authorities upon starting the business.

Nonresidents are required to appoint an Israeli tax representative and VAT representative if any part of their activities is conducted in Israel.

The VAT representative is deemed to be the tax representative if no other tax representative is appointed. The tax representative is empowered to pay Israeli tax out of the foreign resident‘s assets.

What monthly and annual tax filings are needed?

The Israeli tax year is normally the calendar year. However, subsidiaries of foreign publicly traded companies may sometimes be allowed to use a different fiscal year.

Companies are generally required to file audited annual tax returns and financial statements within five months after the end of their fiscal year, but extensions may be obtained. Israeli certified public accountants are usually allowed to spread the filing of the tax returns of their clientele over a period of up to 13 months after the tax year-end.

Companies and other businesses must also file short monthly returns on account (bimonthly sometimes if the business is small) accompanied by tax payments.
This applies to the following taxes:
  Company tax installments, which are typically computed as a percentage of a company‘s monthly sales revenues.

  Supplementary company tax installments with respect to certain nondeductible expenses (odfot).

  Tax withheld from salaries and remittances to certain suppliers.

  NII payments.

  Value-added tax (VAT).

These filings and payments are made by the 15th day after the month-end at a local post office or bank. If you are a few days late, a computer-generated penalty is usually issued.

Detailed bookkeeping and invoice requirements are contained in the income tax and VAT regulations. In practice, most taxpayers use bookkeeping software packages approved by the ITA. The books and returns should be in one of the official languages: Hebrew or Arabic. In practice, though, English is usually tolerated by most tax offices.

The accounting records should be available for inspection in Israel by tax officials. Multinational groups wishing to use international online systems in English may do so if they obtain approval from their tax office.

What about expenses?

Expenses are deductible if they are incurred wholly and exclusively in the production of income, provided any withholding tax due is paid. In the case of most domestic Israeli expenses, withholding tax rates of up to 30% (sometimes more) are prescribed unless the recipient holds confirmation from the ITA allowing a lower rate. You can check your supplier‘s withholding tax status on the ITA‘s Web site.

In the case of remittances out of Israel, the Israeli banks must withhold tax, generally at a rate of 25%, unless the remittances relate to imported goods. A withholding-tax exemption or a reduced withholding rate may be obtained from the payer‘s tax office in certain other cases, such as when a treaty applies or when the payments are for services that are rendered entirely abroad.

How much Israeli tax will there be on profits?

Freelance individuals pay income tax on taxable income at rates ranging from 10% to 45%, plus NII payments.

NII rates range up to 16.23% on the first NIS 79,750 ($21,000 approximately) of monthly income, but 52% of these payments are deductible for income-tax purposes in the year they are paid, resulting in an effective combined maximum of around 57.4%, decreasing to 45% beyond NIS 79,750 per month. In 2011, the maximum income-tax rate is scheduled to decrease 1% to 44% with further reductions in subsequent years.

For companies, the regular rate of company tax is scheduled to decrease from 25% in 2010 to 24% in 2011 with further reductions in subsequent years. Subject to any tax treaty, the standard rate of dividend withholding tax is 20% for shareholders who hold less than 10% of the company and 25% for 10%-or-more ‘‘material shareholders.‘‘

Consequently, in 2011, distributed profits will generally be taxable at 39.2%-43%.

Incentives in a nutshell

Israel offers generous tax breaks for ‘‘privileged enterprises‘‘ and ‘‘approved enterprises‘‘ in industry, technology and tourism.

First, there is the ‘‘green channel‘‘ tax package: zero company tax for retained profits. If and when profits are distributed as dividends, the company tax rate will range from 10% (if foreign ownership is 90% or more) to 25% (if foreign ownership is below 49%). The company tax benefit period is seven to 10 years.

In addition, there will be a 15% dividend withholding tax.

Second, there are fixed-asset grants and tax breaks for an ‘‘approved enterprise‘‘: the grants range up to 32%, depending on location, and company tax rates range from 10% to 25% for seven to 15 years. If profits are distributed, a 15% dividend withholding tax also applies.

However, a revised system of tax breaks has now been proposed.

Under the proposals, the incentive packages would be: (1) a tax-break package; and (2) a grant and loan package.

Under the tax-break package, it is proposed that a uniform rate of company tax would apply to all income of industrial export companies (more than 25% of revenues from exports).

In 2011-2012, the proposed uniform rate of company tax would be 10% in Development Area A and 15% elsewhere in Israel from business activity in Israel. Starting in 2013, the proposed rates of company tax would decrease to 8% in Development Area A and 12% elsewhere in Israel.

In addition, certain ‘‘special industrial enterprises‘‘ may be granted a further reduced company tax rate of 5% in Development Area A and 8% elsewhere in Israel. Under the proposals, it would no longer be necessary to invest in productive fixed assets. Dividends would remain subject to a 15% withholding tax.

Under the grant and loan package, it is proposed that the government‘s Investment Center Board would be empowered to generate incentive packages that encourage innovation and efficiency with highly significant benefit to the economy and investment in manpower.

The packages may include professional training, loans to small and medium enterprises, etc. The board would determine grants in Development Area A, with at least 25% of revenues from abroad, of up to 24% (including an administrative grant of 4%).

No tax breaks would be available to government companies or mining, oil and gas enterprises. Partnerships would only be eligible if they are owned by Israeli companies and the plant is an industrial exporter as discussed above.

If enacted, the proposals would apply to income generated starting in 2011 by competitive industrial companies. Existing entities may be allowed to transition to the new benefits.

Research & development grants are available from the Chief Scientist‘s Office at rates ranging from 20%-50%. In general, royalty payments are 3%-3.5% of the total annual revenues derived from the sales of a developed product in which R&D was supported by Chief Scientist‘s Office grants.

In addition, the Israeli government has entered into 29 bi-national industrial R&D support agreements all over the world and participates actively in five multilateral European programs.

What about any future exit?

With regard to capital gains, subject to any tax treaty, foreign residents are taxable on Israeli source ‘‘real‘‘ (inflation adjusted) capital gains at varying rates (individuals: 20%-45%; companies: 25%).

Nevertheless, foreign-resident investors not doing business in Israel may enjoy an exemption from Israeli capital-gains tax (tax only in the investor‘s home country) when they sell Israeli securities acquired on or after January 1, 2009. This does not apply to Israeli real-estate related investments. Different rules apply to pre-2009 investments.

As always, consult experienced tax advisors in each country at an early stage in specific cases.

Leon Harris is an international tax specialist at Harris Consulting & Tax Ltd
[email protected]