When an int‘l firm has an employee in Israel

When an int‘l firm has an employee in Israel


The Israel Tax Authority (ITA) has published an anonymous tax ruling about a foreign financial institution that employed an Israeli resident individual and had a taxable �permanent establishment� in Israel (Ruling 253/12 issued July 1). A permanent establishment is generally a local fixed place of business (branch) or a �dependent agent� (employee) of a foreign company. This ruling will be relevant to all foreign firms with one or more employees in Israel.

The main facts

According to the ruling, a foreign company (Company A), based in the US, provides financial services to clients entirely outside Israel and does not market them in Israel. Company A has hundreds of employees.

Company A has signed an employment agreement with Ms. Alef, an Israeli resident, appointing her as Portfolio Manager. Alef works from home in Israel as part of a team of four employees, one of whom is the team leader. Alef�s role is: developing and applying the team strategy, unrelated to any specific client, subject to risk-control constraints; credit analysis to assess securities being shorted; monitoring securities that risk dropping in value.

The overall strategy is set by the client. Alef does not conduct any sales or marketing activity, negotiate with anyone, advise clients or meet with clients in Israel. She does meet clients (apparently abroad) once every six or 12 months with team leaders to review the past period and explain potential strategies regarding the portfolio.

Alef has limited independence; in general, all commercial strategy and other ideas regarding securities must be approved by the team leader. In rare instances, if the team leader is not available, Alef must consult at least one other team member.

Company A supplies Alef with office services, trading services, personnel, billings, financial data and technology.

The ruling implies, but does not say, that Alef is the only employee of Company A in Israel.

What the ruling decided

The ruling states that Company A has a taxable permanent establishment in Israel pursuant to Article 5 of the US-Israel tax treaty. This was because of the work in Israel of its employee, Alef.

Therefore, Company A is required to report its income to the ITA. This income is stated to be 10 percent of the gross salary, benefits, bonuses and expense reimbursements of the employee. This is usually referred to as the  cost plus 10% basis  because the Israeli permanent establishment must bill the Company A head office 110% of its costs to leave a taxable profit of 10% of its costs. This is so long as Company A does not conduct a transfer-pricing study reviewing the   arms length  (market-based) income of the Israeli permanent establishment.

Interestingly, the ruling allows the cost-plus billings to be restricted pro rata to the days Alef works in Israel divided by the total number of work days in the year.


This ruling clarifies that any non-Israeli firm with even one employee in Israel is exposed to Israeli corporate taxation on its Israeli source profits. This is the case if the company has no office in Israel and the employee works from home in Israel. This is in addition to home-country tax reporting. Currently, the rate of Israeli company tax is 25%. There is no additional �branch tax� on profits repatriated from Israel.

The ruling appears to validate the use of a cost-plus 10% basis in similar cases, which may help save the time and expense of a transfer-pricing study.

The foreign company should, of course, check whether it can claim double tax relief in its home country, such a foreign tax credit. The US allows foreign tax credits but subject to detailed rules and limitations.

The employee is also subject to Israeli income tax (up to 48%) and National Insurance Institute (social security) payments (up to 12% for the employee, 5.9% for the employer).

The foreign employer is responsible for operating an Israeli payroll withholding-tax file to collect and pay these taxes to the Israeli government.

Regarding the value-added tax, the permanent establishment must register and report for Israeli VAT purposes. Its billings will attract a 16% VAT liability (instead of 0%) of Israeli services relate to Israeli residents, foreign residents in Israel, assets in Israel, or an agreement involving an Israeli resident. Israel is not an EU member, so the EU 13th Directive VAT exemption cannot apply.

Olim who work in Israel for their old firm abroad are often shocked to discover that their 10-year Israeli tax holiday does not apply to income from work done in Israel.

The exemption only applies to income earned while they are physically abroad.

Of course, things can be done differently; other structures exist and are often preferable in such cases, and it seems no action was taken in this case until late in the day.

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

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Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.

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