We often encounter the issue of the combination of treaty provisions designed to prevent redundancy, and the provisions of the tax ordinance in Israel. The basic principle that applies here is that the provisions of the treaty supercede those of the internal law. A qualification for this rule is that in cases where treaty provisions worsen the taxpayer’s situation, the more lenient provisions of the internal law remain in force.
One of the subjects affected by the issues of the combination between ordinance provisions and treaty provisions, is that of residency for tax purposes. We shall give three examples:

1. Foreign Professional Company (FPC): This is in essence an anti-planning provision that determines that the income of a foreign company from professional activity (such as services) performed by its Israeli shareholders is subject to tax in Israel, payable by those shareholders, as a deemed dividend. A circular recently publicized deals, among other things, with the definition of such a company.
   The basic condition is that this involves a foreign company. The circular discusses a case in which a company is considered a resident of Israel in accordance with Ordinance provisions (for example, when the company has been incorporated in Israel); however, in light of the provisions of the relevant treaty, the company is considered a resident of the treaty country (in light of the tie breaker rules applied with regard to a company, usually a test of the effective place of management).
   In such a case, the circular determines that a company should be seen as a non-Israeli company, even if this decision derives from the treaty provisions only; therefore, the relevant anti-planning provisions shall apply to its shareholders.
   Another interpretation may lead to the conclusion that on the one hand the company shall not be taxed in Israel for its income outside of Israel (since according to treaty provisions it is not a resident of Israel) and on the other hand the FPC anti-planning provision shall not apply (since this does not involve a non-Israeli company according to Ordinance provisions).
2. Exit tax: How are the exit tax provisions stipulated in Israeli law applied, in the event in which a person is still considered an Israeli resident according to the provisions of internal law, since he has not yet transferred the center of his life to the relevant foreign country; however, the same individual is already considered a resident of the treaty country according to treaty provisions (the tie breaker rules in the residency section). The question asked is, what law applies in a case in which that person, during the same “twilight period”, sells an asset he had abroad. If it is claimed that exit tax provisions do not apply, since pursuant to internal law the status of residency remains unchanged, then at the sale’s stage no tax shall apply in Israel, since that person is not a resident of Israel according to treaty provisions, and in any case is not seen as one who has sold the asset prior to severance of his residency. If the Tax Authority should claim that change of residency, according to treaty provisions alone “triggers” the exit tax, then the portion of capital gains attributed to the period of Israeli residency may be taxed at the sale’s stage, according to a linear mechanism. The Tax Authority hasn’t published an official announcement of its stance on this matter; however, to the best of our knowledge, its position is that the exit tax applies even if the change of residency is according to treaty provisions only.
3. New immigrants: Let‘s assume a case of an individual gradually returning to Israel from a treaty country after living there for nine years. We assume that at that time, according to the Israeli Tax Ordinance provisions he is considered a resident of Israel; however, according to the tie-breaker rules in the residency section, for the next two years he shall still be considered a resident of the treaty country; in other words, according to both the internal law and the treaty, the individual is considered a non-resident of Israel for 11 years. Will those two years in which the individual is considered a non-Israeli resident according to treaty provisions only, lead the individual to “safe shores” as a “veteran returning resident” (a unique status given an individual who was a foreign resident for at least 10 years is exempt from tax and reporting for 10 years)? The Tax Authority’s position on this matter is negative, as publicized in the professional circulars and decisions on taxation with regard to this issue, and as its aforementioned position – that the non-Israeli residency period according to the treaty only shall not be included in seniority counted for the purpose of determining the status of a “veteran returning resident”; this status shall be determined only if the individual was a non-Israeli resident according to Israeli Tax Ordinance provisions for the required period of time.

In our opinion, in light of the Tax Authority’s stance on residency of a Foreign Professional Company as stated in Section 1 above, and its apparently similar stance on application of exit tax as stated in Section 2 above, cases of “veteran returning residents” should be treated analogously – counting years of non-Israeli residency under the treaty as non-Israeli residency under Ordinance provisions as well; and, as continued above, giving that individual benefits entitled to “veteran returning residents”, since it doesn’t make sense for the Tax Authority to seek to apply the rule only in cases in which tax may be imposed, and not apply it in cases where tax benefits are appropriate.