A few weeks ago, the Tax Authority published a new form, the title of which is “Annual report for a foreign resident company that has an exempt capital gain from the sale of securities that are traded on a Stock Exchange in Israel”. Amazingly, the form was removed one day later and as of the present time, it is not to be found on the Authority’s website. Prima facie, this is a procedural matter, however, its very distribution (which may come back again), and its contents, raise a number of questions.
The legislative framework
The Income Tax Ordinance exempts a foreign resident from tax on capital gains from the sale of securities that are traded on the Stock Exchange in Israel. However, the tax benefits or the exemptions for a foreign resident company are denied if 25% or more of the means of control in it are held by Israeli residents. In such a case, it is possible that the foreign company will be entitled to an exemption under the provisions of the relevant tax treaty.
At the procedural level, a foreign company that has income in Israel is required to submit an annual report in Israel, as compared with a parallel provision regarding a foreign individual, who is only required to submit an annual report if he has taxable income in Israel. There is a provision in the “Exemption from the submission of a report” Regulations, which exempts a foreign resident from the submission of an annual report in certain circumstances, but which does not include capital gains even if they are tax exempt.
In light of the aforesaid, theoretically, a foreign resident company, which has generated capital gains from the sale of securities that are listed for trading in Israel, even where they are exempt from taxation, requires the submission of an annual report. This theoretical duty also exists in respect of an investment account that is managed in the foreign company’s country of residence by a local broker. However, to the best of our knowledge, the practice that is customary is that such foreign companies were simply not submitting reports in Israel if all of their income is exempt, as aforesaid, and it would have been appropriate to amend the regulations that afford the exemption from the submission of a report to a foreign resident under certain conditions, such that a clear exemption for foreign residents would be made available on the sale of securities that are listed on the Stock Exchange as well, instead of providing an alternative procedure for submitting the reports.
Apparently, the said form constitutes an abbreviated report for reporting on exempt income, instead of a full annual report, which is a “welcome” relief for investors. However, in relation to the current practice, the publication of the form constitutes a call for foreign companies that invest in Israel to submit reports (albeit within the framework of that same abbreviated report). The form is not submitted to the Assessing Officer but rather to the Capital Market Department and to the Professional Division, and it includes the details of the foreign company, the details of the securities portfolio accounts and certain declarations of the foreign corporation.
The foreign company is required to declare, inter alia, that:
It is a foreign resident in accordance with the definition in the Israeli Tax Ordinance, i.e., the absence of “management and control” in Israel;
It does not have a permanent presence in Israel (without a clear definition of what a permanent presence means);
There is no holding in it (directly or indirectly), by Israeli residents at a rate of 25% or more. In effect, the Company is required to declare that the section in the Ordinance on the conditions for the granting of reliefs to a foreign resident applies to the case in hand, however, for this purpose it needs to clarify who the ultimate shareholders are and this may not be a simple matter in certain cases.
The exempt income is reported in the foreign corporation’s country of residence! In effect, the Tax Authority in Israel is implementing the directives issued by the Bank of Israel to banking institutions in Israel, which are required, in accordance with those directives, to clarify that a foreign resident, who holds an account in that is maintained in that bank, is in compliance with the tax laws in its country of residence. We would mention in this connection that there is no tax implication in Israel for the absence of reporting abroad (and sometimes no reporting at all is required abroad in accordance with the tax laws in that country), in other words, the foreign company will still be entitled to an exemption under the provisions of the Ordinance! And the question needs to be asked – why is such a declaration required? Is it for the purpose of an initiated transfer of the information to the other country? For this is not required in light of the existence of a mechanism for the transfer of information automatically regarding bank accounts between most countries (CRS).
The content of the declarations and the fact that this is a form that is recorded in the Hebrew language alone – in contrast to other forms, which are intended for foreign residents and which are (also) written in English – may provide a hint that the Tax Authority is trying to identify foreign companies that are held by Israelis indirectly for considerations relating to the avoidance of taxation. If this is indeed the intention, it will be possible to instruct the banking institution in Israel in which the foreign company’s investment account is maintained to sign it on such a declaration (to the best of our knowledge, in any event foreign residents are required to sign on certain similar declarations to the bank), and to report to the Tax Authority on those cases that have been defined as being reportable, instead of placing the procedural burden on all foreign investors, and it is possible that some of those investors will simply choose not to invest in Israel in order not to get into the net of reporting to the Israeli Tax Authority.