A Limited Liability Company (LLC) is popular with Americans, because the LLC generally isn’t taxed in the US, only its members (shareholders) are. This is referred to as fiscal transparency or flow-through treatment. It may save US tax. But Israeli residents are taxed in Israel too.
In the Yaacov Harel Case, Mr Harel held 100% of Yoni Simul Ltd, an Israeli family company which in turn owned 67% of ISOA LLC in the US (Case ref: 55858-12-15 of 22.2.17 and 4030/17 of 3.7.18 and 5453/18 of 31.5.18).
Yoni Simul Ltd was fiscally transparent for Israeli tax purposes, and ISOA LLC was fiscally transparent for US tax purposes.
ISOA LLC was in the business of selling health insurance to foreign students in the US. In 2012 and 2013 ISOA LLC paid no US tax but it distributed profits of around NIS 15 million to Yoni Simul Ltd and withheld NIS 3.5 million (in US dollars) of US tax pursuant to Section 1446(d)(2) of the US Internal Revenue Code (IRC).
The taxpayer apparently refused to explain how the US taxes were calculated or why they were paid. The taxpayer merely claimed the profit distribution was effectively a dividend on which he was personally taxable at 32% in the relevant years less a credit for the US tax already paid. Therefore, the taxpayer claimed there was only a small balance of tax to pay in Israel. The taxpayer took his case all the way to the top but the Israeli Courts didn’t agree. Why not?
The Israeli Supreme Court twice upheld the facts and process applied by the District Court.
Rule number one anywhere is don’t upset the judge by wasting the Court’s time. The District Court judge clearly thought the taxpayer was less than forthcoming and proceeded to research the issues and flatten the taxpayer’s claims.
The Courts found that an LLC is a body of persons for Israeli tax purposes like any other company in Israel or abroad. In this case the Courts found that the tax withheld in the US under IRC Section 1446(d)(2) was not tax on a dividend, it was US tax on business profits of the LLC. This broke not one but two rules regarding foreign tax credits in Israel.
First, the taxpayer could not credit US tax on business income against Israeli tax on distributions by the LLC which are treated as dividends not business income.
Second, Israeli tax law generally does not allow an individual to credit foreign corporate taxes.
Moreover, the District Court criticized the taxpayer for not electing a procedure for avoiding double taxation in LLC cases in Tax Circular 5/2004. This limits tax in the two countries to a maximum of 50%, sometimes less. But you have to elect Circular 5/2004 in the first relevant tax year.
To Sum Up:
The result, was the taxpayer lost the case and ended up paying a combined US-Israeli tax rate of around 56%. If you have an LLC, take the above into account and consider whether to elect Circular 5/2004 in the first relevant tax year.
Also, an LLC generally offers no protection from US estate taxes of around 40% or more for US investments totaling over $60,000 by non-US persons.
Estate tax can be blocked by having an appropriate structure in place – there are several possibilities. So beware of LLC’s. For non-US persons LLC means Lateness is Lazy & Costly.
Please contact us to discuss such structures and the available alternatives.
As always, consult experienced tax advisors in each country at an early stage in specific cases.