Overseas companies, part 3 - the Foreign Professional Company

Another type of company that the Israeli tax office doesn't like is one where a profession is carried out abroad, and the profits are not directly taxed in Israel. As such, the tax law sets out rules for a Foreign Professional Company (FPC). These rules were revised for 2014, and below are the new rules.

What is an FPC?

In order to be an FPC, the foreign company must meet the following criteria:

(1) Be owned by fewer than 5 people. For these purposes, members of the same family or business partners count as a single person.
(2) At least 75% of the ownership and control of the company are held by Israelis. For these purposes, those within their 10-year exemption period are not considered Israelis.
(3) The majority of the income of the Company is from a "Special Profession"
(4) Controlling shareholders, who together control at least 50% of the company, work for the company in the "Special Profession," either directly or via another company that they have control over.

What is a "Special Profession"

The Regulations give a closed list of professions that are considered "Special Professions" for these purposes. They are the following (translation of list in alphabetical order in the Regulations):

• Security
• Agronomist
• Architect
• Art, including creation of art
• Music & entertainment
• Audit (of various types)
• Modeling
• Teaching & seminars etc.
• Engineering
• Veterinarian
• Creating and operating computer hardware
• Computer software
• Investigations
• Aircrafts & boats
• Telecommunications
• Representation of any "Special Profession"
• Advice, including the fields of financial, personal, security, agriculture, technical, engineering, organisational, management, national, scientific, tax, business & economic
• Economics
• Writing & composition
• Scientific research & development
• Management - including assets & investments, companies, organisations, institutions, businesses - including those in the process of dismantling, bankrupcy or administration
• Statistics
• Sport
• Journalism & editing
• Advertising & public relations
• Lawyers, patent attorneys, representation before law
• Photogoraphy
• Accountancy
• Medical - including developmental treatment, psychology, physiotherapy & dentistry, and including para-medical and alternative medical services
• Religious services
• Surveying
• Realty
• Translation
• Communications & event organisers

How is the FPC taxed?

The taxation of the FPC essentially turns the company into an Israeli company. The twist is that it is the shareholder who is taxed on his/her portion of the income, rather than the company itself (this is the major change from the previous version). The rate of tax on this income is the corporate rate of tax (26.5% for 2014).

The profit of the company is calculated according to Israeli rules, unless the company is resident in a country with which Israel has a tax treaty - in this case the local rules apply.

Any tax paid in the country of the company's residence can be claimed against the tax due.

The rules for tax on dividends paid are similar to that of any other regular Israeli company, although there are some subtle differences. This is not the place to go into detail.

Some points

Since the Israeli tax rate is amongst the highest in the world, these rules can hit people hard financially, and not just in the increased burden of reporting.

There may be a thought to get round the tax issues by zeroing out profits abroad by way of management fees to an Israeli entity. This though leads to issues of transfer pricing whereby the foreign tax authority (and potentially the Israeli authority as well) may challenge the approach in order to increase their own tax take.

Due to the complicated nature if these companies, it is highly recommended that tax specialists and experts in both countries are consulted before going ahead with such schemes.

Overseas companies, part 2 - the Controlled Foreign Company

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One of the suspected tax planning methods that the Israeli government doesn't like is for those investing overseas to form a company on a tax haven to hold the investments. The thinking would be to hold the investments within the company without withdrawing any funds, and thereby not pay any Israeli tax on the income until funds are needed.

As such, the tax law includes a section on Controlled Foreign Companies (CFC), whereby the Israeli shareholders are deemed to have received a dividend based on their share of the profits of the company, even if they didn't actually receive them.

A CFC is defined as follows:

1. A company resident outside Israel (see here for more), where the tax rate in the country if residence is no more than 15% (from 2014. It was 20% previously).

2. The majority of the income of the company is from passive income (interest, dividends, royalties, property, capital gains), or is based on such income - this prevents a holding company being used to get round the problem.

3. The company is a private company, or no more than 30% of the shares are available to the public.

4. More than 50% of the control of the companies are held by Israelis. This needs to hold true either on 31st December or on at least one day of the tax year and one day of the following tax year. For these purposes, people within their 10-year exemption period do not count as Israelis.

There are rules regarding ownership via a string of holding companies, which are too complicated for the purposes of this blog. Suffice to say that you should take advice if necessary.

If the country in which the company is resident taxes dividends, you can get a tax credit for taxes that will be paid (in the future) on the undistributed profits which are currently being taxed.

It should be noted that the profits under discussion are those profits made from passive income after deduction of any (corporate) taxes due on the income as well as after offsetting any losses that may have accrued in the past or in the relevant tax year.