Tax consequences to an Israeli resident holding an LLC in the US

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Many Israelis carry out activities in the US through holdings in an LLC type corporation. In the past, particularly up to and including 2002 (prior to the reform in Israel of taxation abroad), there were tax advantages for this form of activities. In 2004 Income Tax in Israel published a professional circular regarding the tax consequences of these type of activities, as a result of the tax reform.

According to the tax laws in the US, the existing default for an LLC is relating to it as a “transparent” body for tax purposes, i.e. the income is considered as income of the persons holding it (similar to a partnership). Nevertheless, the LLC can choose to be considered for tax purposes in the US as a regular company.

As there is no special reference in the Israeli tax laws, then from a legal aspect in Israel the LLC is considered as an ordinary company, whose income and losses do not relate to the holders of it. i.e., a situation is created in which the Israeli individual paid tax in the US on the LLC’s income, where in Israel this income does not relate to him. In addition, Israel will impose a tax on the withdrawal of profits from an LLC (similar to the withdrawal of a dividend) and will not credit him for the tax he paid in the US, because, as mentioned, the tax paid on income of an LLC which is legally a separate body from the individual holding it, from the point of view of the Israeli law.

In the professional circular, Income Tax enables a solution regarding the credit from foreign tax, in such a way that Israel will enable a credit for the tax paid abroad, on condition that the holder of the LLC will report on income in Israel on a current basis.

Should the LLC choose to be considered a company for tax purposes in the US, then also in Israel it will relate to it as a company. In such a case, no double taxation will arise and this as the attitude of the two countries is similar. Nevertheless, we draw attention that there are liable to be other tax debits in Israel due to the holding of an LLC (directives regarding a “foreign controlled company”, or “a foreign profession company”).

If the LLC chose to be considered as transparent in the US then Income Tax in Israel differentiates between two cases:

  • When control and management of the LLC business is from Israel, then the corporation will be considered as an Israeli resident, and reporting must be done on a current basis on its income in Israel and it will be liable to corporate tax in Israel. Concurrently, Income Tax will enable a current credit for the tax paid by the holder of the LLC as if it was paid by the corporation itself. At the time of distribution of dividends to holders this will be seen as a dividend, which is liable to an additional tax of 30%.

  • When control and management of an LLC business are not from Israel, then the corporation will be considered as a foreign resident. In order to solve the problem of double taxation described above, Income Tax will enable the Israeli holder to report in Israel on income of the LLC personally (an individual – as ordinary income up to the maximum marginal tax rate). Concurrently a credit will be given for the foreign tax paid by the holder. In addition, at the time of distributing profits to the holder, this will not be considered as a dividend and an additional tax will not be imposed.

At the time of selling the holdings in the LLC (or at the time of liquidation) the capital gains tax in Israel will be calculated after relating to the profits which were already taxed in Israel so that they will be deducted from the consideration received at the time of the sale.

We should emphasize in addition the following points:

  • The proposed arrangement will only be activated if the taxpayer requested to impose on him the arrangement mentioned above, already in the return submitted for the 2003 tax year. It will not be possible to change this choice in the coming years. A notice regarding the method of reporting on income from the LLC and the foreign tax credit must be attached to the annual tax return.

  • The credit rules on taxes paid abroad against income tax in Israel are very complex. That mentioned above will not change the various rules and restrictions set forth in the law regarding a tax credit, but will add the attitude required to the question of the LLC.

  • As mentioned above there is no change in the other relevant taxation consequences. For example, losses from the operation of a corporation abroad will not be related to the holder but will remain to be setoff at the level of the LLC.

  • Regarding the LLC., there are additional tax consequences and the possibility of tax planning to anyone who was an Israeli resident and became a foreign resident, and vice versa. Therefore, there is considerable importance to determining the status of the Israeli resident, foreign resident, returning resident or new immigrant, for tax purposes. Not ensuring proper planning will result in serious tax exposures and national insurance consequences. It is advisable not to leave this to chance, but to make the required preparations.

With the intention to encourage returning residents, Israel grants various types of excellent tax benefits. The following is a condensed list of the income tax benefits and the years of entitlement to these benefits from the date of return to Israel:

  “Ordinary” returning resident New immigrant / “veteran returning resident”
Tax exemption on “passive” income (income which is not from a “business”) 5 years 10 years
Tax exemption on capital gains from the sale of assets abroad 10 years 10 years
Tax exemption on income from business and professions produced abroad None 10 years
Tax exemption on income from salaries produced abroad None 10 years
Relief from the test of residency regarding companies abroad: “Control and management”, “a foreign professions company”, “foreign controlled company” None 10 years
Possibility of a “year of acclimatization” – notice to the Ministry of Absorption within 60 days from the date of return None 10 years
Exemption from the obligation of disclosure and reporting (annual tax returns and capital declarations) None 10 years
Fixed exemption from capital gains tax from the sale of securities in an Israeli company if at the time of the purchase the purchaser was a “foreign resident” None Permanent

An “ordinary” returning resident is an individual who was a foreign resident and returned and became an “Israeli resident” after at least 6 continuous years abroad, while a “veteran” returning resident is an individual who was a foreign resident and returned and became an “Israeli resident” after at least 10 continuous years abroad.

Moreover – recently a revolutionary verdict was issued by the Supreme Court which enables separation of residency for tax purposes between a couple. There is nothing to prevent in principle a situation whereby one spouse is entitled to a tax benefit as a “returning resident” (ordinary or veteran) and the other spouse continues to have the status of a “foreign resident”, i.e., exemption from reporting in Israel on his activities abroad and various tax benefits in Israel, depending on circumstances.

With correct planning it is possible to increase these tax benefits by establishing a local Israeli company which will separate between the various activities in Israel and those abroad, in addition to tax planning by establishing an Israeli company with local operations. A suitable combination of these benefits opens the possibility of interesting tax planning which are attractive to many of the returning residents and new immigrants. In particular, this relates to individuals, residents of a country with whom Israel has a tax treaty to prevent double taxation.

On the other hand, one should mention that often in practice it becomes clear that beneficial legislation in the Knesset will be examined stringently by Income Tax. My recommendation is to obtain tax consulting in advance regarding the specific circumstances of every case, both about the period of stay abroad and the time of return to Israel. This in order to best utilize the tax and national insurance advantages and to avoid unpleasant traps.