International taxation - Issues in attributing income of a foreign company to Israel
On October 2016 taxation ruling 6631/16 was published, dealing with determining the existence of a permanent establishment for a foreign company and attributing income to Israel.
Facts and details: A foreign company that is not a resident of a treaty country (“the Company”) deals among other things in providing international money transfer services, for the purpose of which the Company has engaged with a non-related foreign clearing company, resident of a treaty country (“the Clearing Company”), as well as currency service providers serving as subcontractors around the world.
In conducting their regular business, the above provide money transfer services, in effect constituting “end points” the final customer reaches when interested in transferring money from one end point to another. The Company conducts an elaborate operation of activity in connection with the clearing services which includes conducting business vis-a-vis the clearing company, operating supporting IT systems and a customer service system, and making decisions pertaining to the end points and other various actions. All of the aforementioned actions are performed outside of Israel by the Company’s foreign employees.
Due to regulatory requirements connected with the clearing activity in Israel, the Company has established an Israeli subsidiary (“the Israeli Company”) whose job it is to oversee compliance with regulatory requirements and other actions the nature of which is, apparently, auxiliary to the Company’s core activity.
Fund transfers are performed from one end point (in Israel, for example) to another end point in the destination country, through a chain of factors: the end point, the Company (through its bank account in Israel), the clearing company, an agent of the clearing company in the destination country and the end point in the destination country. All of the above receive a part of the fee paid by the customer for the transfer. In effect, the Company’s only income is the part of the fee remaining in its hands.
The taxation ruling determines that part of the Company’s income should be seen as if generated in Israel, both due to its activity in Israel through the Israeli company and the existence of end points in Israel. However, it is not a treaty country; if this were the case it could be claimed that the end points acting over the course of their regular business constitute in effect an “independent agent” as its meaning in the tax treaties, and therefore no Permanent Establishment has been established in Israel. It would subsequently be claimed that the activity of the Israeli company is only auxiliary to that of the Company, and nor does this type of activity establish a Permanent Establishment for the Company. In our opinion, even when not in a treaty country, it would still be appropriate to attribute less weight, if at all, to the role of the end points and the Israeli company.
Later on, the taxation ruling determines that the profit attributed to Israel will be determined according to the ratio of expenses made in Israel and total Company expenses with respect to activity in Israel (including expenses of purchases made abroad).
In our opinion it should first be clarified (and this matter is not clear from the taxation ruling) whether these expenses made in Israel also include the fee charged by the end points in Israel. Our position on this matter is that these are not Company expenses at all, since from the accounting standpoint it appears that its income includes only the fee to which it is entitled and not the total fee paid by the end customer after deduction of the fees charged by the other factors in the chain as stated above. If the intention is to include these fees as expenses of the Company, then the rest of the fees charged by the other factors in the chain are considered mainly as expenses outside of Israel.
Company expenses apparently include operation costs due to the activity of the Company described above, and the costs of the Israeli company. In light of the aforementioned circumstances, it would definitely be appropriate to attribute less weight to Company expenses made by its employees outside of Israel as opposed to expenses of the Israeli company, since the nature of actions performed by the Company outside of Israel is substantive and of a higher contribution compared to the nature of actions performed by the Israeli company. Generally speaking, it may be that the income attributed to Israel, if at all, should be calculated only according to the “Cost Plus” method derived from the expenses of the Israeli company; again, due to the purely auxiliary nature of the activity performed by it (it may be that the stated method was determined simultaneously with determining the taxable income of the Israeli company).
In addition, the mechanism determined for attributing the profit to Israel does not take into account other Company assets that contribute to its profit generation, including intangible assets (reputation, know-how, designated software, etc.) nor does it take into account the element of risk to which the Company is exposed as opposed to the supposedly risk-free activity performed by the Israeli company, and perhaps the method of profit attribution determined as stated simultaneously assumes attribution of this intellectual property and risks to Israel.
