Overseas companies, part 1 - General issues

It is fairly common for people to invest overseas, be it in businesses or other assets (eg property, shares etc.). One of the most common ways to invest is to set up a company in the country of investment, owned by the foreign investors.

The first issue that Israelis must consider when setting up a foreign company is the residency of the company. Any company incorporated in Israel is automatically considered Israeli-resident, but an overseas company can also be considered Israeli-resident if it is "controlled and managed" from Israel.

The concept of "control and management" refers to the activities of the company (at the comany level), NOT the actual underlying business or investment. Although the law does not define these terms clearly, the concepts developed in the court cases relate, primarily, to shareholder and board meetings discussing the overarching strategy of the company.

If the company were to be set-up in a country with which Israel has a Double Tax Treaty, the Treaty will set criteria for determining where the company would be considered resident. As such, it is likely to be the country in which the company is incorporated. The issue though is particularly acute when setting up companies in countries with which Israel does not have a Double Tax Treaty (Australia would be a classic example).

The implication of the company being considered Israeli-resident is that (a) the company would be required to file Israeli tax returns (taxes being levied at the Corporate Tax Rate, currently 26.5%), and (b) there is the potential for foreign taxes paid not to be recognised.

As such, it is important to consider the residency of any company that is intended to be set-up, so as not to fall into any traps.

In the coming posts, we will look at two specific types of foreign company - the Controlled Foreign Company and the Foreign Professional Service Company.

Spouses - taxation of joint income

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As previously mentioned, tax files in Israel are joint between husband and wife. The question therefore arises as to how joint income is taxed.

In this respect, the law differentiates between earned (eg salary, self-employment, pension) and passive income.

Passive income

In general, passive income is treated as joint income and added to the earned income of the higher-earning spouse.

However, with the exception of using the exemption for Israeli residential properties, any income arising from an asset owned by one spouse for at least one year prior to marriage or from an asset received by inheritance after marriage can be treated as that spouses' income only.

Earned income

In general, spouses' earned income are completely seperate from each other. As such, each spouse's income is taxed separately.

However, there are situations whereby both spouses work in the same business. For this to be an issue, the business must be controlled by one of the spouses (e.g. we're not talking about husband and wife both working in the same hospital)

In this situation, the main spouse in the business cannot give income to the spouse who just helps out - and all of the income must be taken by the main owner of the business. However, the law (effective 1st January 2014) allows the other spouse to get some income of their own, provided that the following three conditions are all met:

1. Both spouses' work is required for the business.

2. Each spouses' income is commensurate with their contribution to the business.

3. If the business is run from the family home, the home is the primary place of business. For example, an electrician with the spouse acting as secretary from home would not meet this criteria.

As this is a new law, it is not entirely clear how the tax authority will approach these situations, and what sort of proof will be required. If this is relevant to your business, take advice!

Tax authority clamping down on non-reporters

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Over the last fortnight or so, the tax authority has sent out a number of letters to Israeli residents whom it suspects have not reported of the income that they are thought to receive - and hence not paid the relevant taxes.

The head of the tax authority told a gathering at which a colleague was present that approximately 93,000 such letters were sent out. There seem to be two main possible lines of approach by the tax authority:

(1) Those owning 3 apartments or more - it is an assumption that there will be rental income over and above the exemption limit. This information would likely have been taken from the Tabu (Land Registry).

(2) Those with foreign sources of income. My guess is that various co-operation agreements have been reached with other tax authorities around the world, whereby names of Israelis with foreign tax files - or perhaps even just incomes that the tax authority know about (e.g. bank accounts, pensions etc.) - have been passed to the Israeli tax authorities.

I have already seen a number of such letters. The first page is a request to fill in the attached form within 30 days, and send it back to a special department that is dealing with these letters. Presumably they will then decide what to do with these (i.e. if to open a tax file, and if so, which years to request, capital statements etc.) and pass their decision onto the local tax assessing office.

The form is the standard form to open a tax file (see here). Whilst most of the details are not normally filled in, in this situation I would recommend giving as much infomation as you can, adding extra details on an appendix if necessary. You may want to consult with a professional before filing the form.

For anyone to whom this may be applicable (including those who haven't been "caught" yet), I suggest reading this post regarding some of the principles of Israeli taxation. Furtheremore, see if you are eligible for exemption from filing a 2013 tax return as per the rules set out in this post.

It has also been rumoured that the tax authority are planning - in the coming weeks - on encouraging people to come forward, sort out the past taxes owed without too much in the way of fines, interest, linkage etc, and getting them into the general tax system - this is known as a Voluntary Disclosure Procedure. However, until formal guidelines are published, it is impossible to say what the incentives will be.

Meanwhile, it is obviously better to come forward to the tax authority rather than waiting for them to come to you. So make sure you are fully compliant!