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Tax planning in connection with Israelis abroad who must report to the Israeli Tax Authorities

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The Income Tax Regulations in Israel set forth a list of “aggressive” tax planning that they intend to fight. “Aggressive” tax planning is characterized by one or more of the following elements: It has no stable economic basis, it relies on a weak verbal technical interpretation, its main purpose is to reduce tax in an extreme way, and does not have reasonable disclosure in taxpayers’ tax returns. Income Tax requires in the annual tax returns reporting on performing such tax planning and if it is of the opinion that the tax planning is not legitimate it will demand a payment of tax accordingly, and also impose a fine at a rate of 30% on the unjustified reduction in tax. A taxpayer who did not report on tax planning, without sufficient reason, will be defined as a criminal. The list requires taxpayers who chose up to now to “conceal” their tax planning to specifically disclose their actions. This does not prevent the taxpayers from dealing with the question of the legitimacy of the planning, but if he fails, he will be obliged, as mentioned, to pay the tax and the fine. There is nothing to prevent the list from being expanded in the future.

The following are two “aggressive” tax plans of the list connected with the activities of Israelis abroad.

  • The holding of an Israeli resident of 25% or more in a company resident of a country which has not signed a tax treaty with Israel: Often this relates to countries where the tax rate is considerably lower than the rate prevailing in Israel (“tax shelter”). Often an incorporation abroad is the result of demands of foreign shareholders (not necessarily for tax reasons) and often as a result of tax planning (of Israeli residents or foreign residents).

 

  • The holding of an Israeli resident of 25% or more in a company a resident of a country which has not signed a tax treaty with Israel, and also 50% or more of the value of its assets or the use of them is in Israel, directly or indirectly. This in order to utilize various clauses which reduce the tax liability. For example, a tax resident uses a company owned by him which is a resident of a tax treaty country, where the treaty stipulates a tax exemption on capital gains from the sale of an asset in Israel. This use is likely to have the taxpayer save capital gains tax on the sale of the asset in Israel (Israel has signed tax treaties with about 50 countries around the world).

 

Other aggressive tax planning according to the list stated above is the transfer of a profit between companies through “management fees”, sales of assets and a waiver of debts, the acquisition of companies with losses and additional acts in the field of land tax and value added tax. By the way I should mention that a “returning veteran resident” as defined by the law has certain exemptions from reporting, including due to some of the aggressive tax planning.

There are many criticisms regarding the list of tax planning published. Its actual legitimacy on determining tax planning, the legitimacy of the fine, on the reporting required and on non-reporting, and its effectiveness and the consequences on privacy that it leads to.  For example, in the two cases stated above: What will happen if at the beginning of the transaction no reporting is required, but it is required during its progress? What happens regarding data which became clear retrospectively? What happens in circumstances which are not controlled by the taxpayers? Reporting as well as non-reporting, is likely to raise many difficulties.

It should be emphasized that the OECD organization published a comprehensive plan including a war against aggressive tax planning called: BEPS – Business Erosion and Profit Split, and it is reasonable to assume that such tax planning will disappear from the world.

Nevertheless, the war against illegitimate tax planning important as it is, should not harm the legitimate and basic right of every taxpayer to legally plan his steps in such a way that will result in a saving in tax payments. This principle has been determined in verdicts of the Supreme Court. The considerable complexity of taxation in Israel, on income and assets from abroad, together with the stronger criticism of the Tax Authorities, requires serious consideration when planning steps (business and private) of Israelis abroad to avoiding tax “traps”.