One of the major tax concepts Israeli inherited from Britain is “control and management”.If the business of a company is controlled and managed in Israel, the company will generally be Israeli resident and taxable on its worldwide income and gains for Israeli tax purposes. This corresponds to the UK concept of “central management and control” which also applies in many British commonwealth countries, such as Canada and Australia.
Although the concept dates back a century, it is still relevant in determining whether offshore companies, and online cyberspace operations are resident and taxable in Israel.
On August 29, 2016, the Israeli Tax Authority issued a supplement dated March 31, 2016 to its original circular 4/2002 of March 3, 2003.
The original tax circular:
The original tax circular says that in view of modern global communications, it is not enough to see where board meetings are held. It is necessary to review the decision making process in a company, where the need emanates from, where are alternatives evaluated, where is preparatory work done, where are professional advisors consulted, where is the final decision taken. This applies to strategic decisions regarding the company’s future, finance, ongoing activity.
Other indicators include delegation to someone, granting discretion to someone, management agreements, day-to-day management, audit, accounting, reporting.
More generally, how much influence does a parent company in one country exercise over the strategic decisions of the subsidiaries in other countries? It is necessary to check the degree of autonomy the subsidiaries have.
The Circular contemds that control and management over a company’s business includes control over passive activities such as real estate investment.
Recent Israeli Cases:
The new supplementary circular reviews a number of Israeli “control and management” judgments issued after the publication of the original circular.
In the Niago case the Israeli Tax Authority (ITA) managed to prove that an international textile trading operation of a Bahamas company was conducted in Hebrew from Israel, by offshore directors (Civil Appeal 3102/12, Israeli Supreme Court, July 14, 2014).
In the Yanko Weiss case, the ITA rejected a claim to capital gains tax exemption by an Israeli-incorporated company that claimed to have migrated to Belgium 9 months before the sale. The District Court agreed that, in practice, an Israeli resident took all the main decisions and the day-to-day decisions on an ongoing basis, not the designated directors who were paid a mere EUR 250 per month. However, the taxpayer won on a technicality as the ITA posted the tax assessment out of time (Income Tax Appeal 001090/06 Dec. 30, 2007; Civil Appeal 85/15, Israeli Supremes Court, Oct 13, 2015).
In the Shai Tsmarot (Oranit) case a real estate company was owned by a US resident, but the District Court accepted that only an Israeli resident was capable of exercising control and management, having regard to expertise, language, data, responsibility for failure, and independent discretion (District Case Tax Appeal 32172-05-13, Nov 11, 2015). This case may yet be appealed.
The new tax circular:
The new supplementary circular says that when reviewing the control and management question, it is necessary to identify who takes material decisions and where is he located – the dominant living spirit. This includes day-to-day decisions as they are not always routine in nature. Are there detailed board minutes or is the board a “rubber stamp” for decisions taken elsewhere?
Management agreement with outsiders should be reviewed, to see what services are provided, how decisions are taken and who takes them. Tax officials are advised to speak with the directors where possible, to help assess their involvement in the company.
The selection of directors should be reviewed – do they have knowledge and experience of the company’s activity? Do they provide management services to a range of other companies? Are they paid a reasonable and acceptable salary for someone who controls and manages a company with all the responsibility such activity entails? Are they fluent in the language used in the business activity of the company? If there are directors from a number of countries, who in practice coordinates between them? Is there anybody with veto powers? Who determines the level of compensation of directors and how they are paid?
If there is an overseas office, is it regularly manned by professionals with the capability and experience to take material decisions? Do they exercise control and management over the company’s activity on a continuous and ongoing basis?
Tax treaties, where applicable, usually contain an “effective management” test of residency. The Circular says this equates to “control and management”
Before going offshore, weigh up who really pulls the strings. And consider the onshore alternatives such as using start-up losses, grants and tax breaks.
As always, consult experienced tax advisors in each country at an early stage in specific cases.
The writer is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.