International Taxation- Dr. Tsilly Dagan- 2009

By Chaim Grushko

Special Thanks to Tobie Harris for making this possible.

These notes are to be supplemented by the charts, graphs, and handouts which were distributed in class.

Class 1:

Introduction:

Tax based on תושבותwill create an even distribution of the tax burden (נטל). Under this doctrine it does not matter where the money was earned. This doctrine also creates incentive to invest abroad. (Reasons that this is bad: low tax revenue, local citizens are made to pay more, not efficient, not fair.) This is also a type of benefit tax in that the residents are the ones to benefit so they should be the ones to pay (but, benefit tax does not really exist anywhere and the doctrine that is used is tax based on ability to pay).

The United States is the only country that taxes based on citizenship.

Israel – What is considered תושבות?

The determining factor is finding where is the person’s מרכז חייב.

The factors that are considered are economic, family, and personal activities.

There is a חזקהthat if someone is in Israel for more than 183 days a year, they are considered תושבים. (This חזקהcan be disproven.) People are often times confused by the מט"חlaw which contains a dry rule that 183 days in the country making someone a תושב. When it comes to tax, this rule is only a חזקה.

פס"ד אריה גונן- Aryeh lived in Israel until 1988 with his family then moved to חולwith his family and worked there. During these years he paid ביטוח לאומיto Israel and his children returned to Israel to serve in the army when the time came. In 1992 Aryeh moved back to Israel with his family. The question is; Was Aryeh considered a תושב ישראלduring the period that he was in חו"לand is his income taxable in Israel during that period? The Supreme Court ruled that תושבותis not binary and the answer is comprised of many factors. In this case for that period the מרכז חייבwas in חו"לbecause his whole family was there and the actions that he did in Israel was just to maintain a “foothold.”

פס"ד גיורה סולר- Giora was an architect who worked abroad for 4 years and during that time filed tax returns in Israel. The court ruled that he is not a תושב ישראלfor that period because you must examine his מרכז חייםand that is abroad.

Some people are under the impression that the rule is that if you are abroad for 3 years, you are no longer considered a תושב ישראלbut such a rule does not really exist.

Should a country be clear or vague about its rules concerning תושבות?

Vauge- you can catch more people and מהותis preferred over צורהwhen this is the rule.

Clear- People will not be freaked out and afraid and not keep any ties when they move away from the country out of fear of being considered a תושב.

The תושבותof Companies- "מקום שליטה וניהול"

To determine this you must figure out:

-Where are the decisions actually reached? Is the person who is really in charge in Israel and making the decisions here even if the leadership of the company is abroad? (you can get around this by actually having the decision making go on abroad.)

Competition for תושביםand תיקון 168:

תושבים(especially companies) are very mobile.

Companies decide on where they will be only based on financial interests.

People are emotional and have loyalty and decide things based on that.

The most mobile people are the rich, talented, and young (they are also the most desireable for a country to get their hands on.)

Why do countries want תושבים?

Corporations- if their administration is in a country that requires a lot of other infrastructure like lawyers and expensive neighborhoods (herzilia).

Individuals- Nationalistic reasons (Israel wants Jews), a country wants the best and brightest minds, and residents are consumers.

תיקון 168: How to get foreign money (both new money and Israeli money that has left)

If you live in Israel then your foreign investments are tax free for 10 years (and then we just hope that you fall in love with the place and stay here).

Although we would prefer getting the tax money on these investments, we are not losing anything by having the people here and there is a lot being gained. (some argue that there are downsides such as the large income/ societal gaps, it is unfair that rich people don’t have to pay taxes, it rewards people who leave Israel and then come back, and these are not the highest quality citizens.)

This תיקוןdoes not require people to even report their foreign income to Israel. (this created a situation that was good for really shady deals.)

Class 2

Double Taxation- There are different ways in dealing with this (circumstance- two countries tax the same income.) There are different ways that this is avoided and the country that generally arranges it is the country in which the person is a תושבand not the host country where the money is being made.

Options for taxing foreign earnings- In order of awesome for the taxpayer.

  1. פטור)Exemption)- If income was taxed once, it will not be taxed again. (best for the citizen.)
  2. זיכוי(tax coupon)- you must make up the difference between the foreign and domestic tax rate.
  3. ניקוי(deduction)- You will have to pay the full Israeli tax rate on the income less the amount of tax that was paid to the foreign country.
  4. DoubleTax- You will pay tax twice on the same income with no recognition by each country of the tax that was paid to the other.

The incentive to invest in chul is higher if the residence country has the more awesome option.

Neutrality- allows for the most economically efficient decisions.

  1. Capital import Neutrality (CIN)- All (tsua) returns produced in a country get the same tax rate. It doesn’t matter where the person who is doing the investing lives. (Here people will live wherever is best for them.)
  2. Capital Export Neutrality(CEN)- I will invest in whatever country is best for me. Because everyone pays the same tax rate on returns, the investor will choose the country to invest in with the highest rate of return.
  3. National Neutrality (NN)- The country where you live will be neutral so long as it doesn’t hurt the country.

CEN supports זיכוי- because the end tax rate is always the same.

CIN supports a פטור, if everyone gives a פטור- because you will only pay taxes to the foreign country because it doesn’t take into account the tax rate in the country where you live.

NN supports ניקוי- because it is only efficient to invest abroad if your net return after tax abroad would be higher then your gross return (before tax) Israel.

*So trying to find the most neutral option doesn’t help because there are different types of neutrality that all lead to different tax doctrines.

What Israel chose to go with is זיכוי.

Sif 200: definitions (requirements for the זיכוי)

  • “מסChutz-” the tax is only on income and you don’t get a זיכויfor the money that you expended on taxes for things like arnona. The exemption is only for taxes paid in the foreign country in which the income was earned (US citizen, Canada Earned, Israel resident example).
  • Only if Israel considers the revenue to be income will the tax paid to the foreign country be subject to זיכוי. It has to be something that falls under one of the mekorot of Israeli income tax law. (This means that we have a game where we put as much of the income that is taxes abroad as income earned abroad and would otherwise be subject to Israeli income tax as far as Israel is concerned.)

Sif 204: There is a limit to the זיכוי(תקרת זיכוי) which is (it is unnecessarily complicated because of tax brackets so we will just get a specific tax rate) that your זיכויis:

If I earn 1000 in chul, 2000 in Israel and you would have to pay 900 tax in Israel then the זיכויwould be 300 because 900 X 1000 / 3000 = 300. But if the amount that would have to be pain in the foreign country is 500 then you would still only get the זיכויon 300 and you would have a 200 odef זיכויthat would still have to paid again in israel (because Israel is nice, but not that nice). An Odef זיכויcan be used for up to 5 years as a זיכויto make up the difference between the amount of tax paid to the foreign country and the amount of the תקרת זיכוי).

Based on this definition it is obvious to make as much income as possible look like income from chul because then the tikrat ha זיכויwould be all that much higher. This lends to all sorts of schemes where income will be recognized as foreign. Different types of income have different rules and there are different games played. For instance for services- the location is where the service is rendered but for royalties it is wherever the royalty is being paid. So if I make a computer program I will say that it is IP that I am licensing and not a service that I am providing. The real trick is that Israel will think of it as IP and America will think of it as a service so I won’t have to pay in Israel or America. Another trick is to manufacture here and have it sold in chul by a marketing company who I sold it to for a slight profit so that all the profit is earned in chul.

Regarding תקרת זיכוי- when Israel is 10%, spain is 20%, and france is 30%- the תקרת זיכויis neutral between Israel and spain but not neutral between france and spain.

And then the Germany- הוןg Kong- Israel Chart.

(Shiur 3)

So why would we have a זיכויif it takes the tax money out of the mouth of Israel and helps other countries?

Because we want residents and we are willing to sacrifice a certain amount of tax revenue in order to get them to live here. (but only until a certain amount- זיכויmugbal- means that the other country can not raise its tax rates above Israel and then Israel be expected to absorb the difference in cost.

(If the host country wants to get the most out of the pocket of a resident country (that uses a זיכוי) they will impose a soak up tax- but most countries will void whatever arrangement there is if a host country imposes a soak up tax and they will no longer give the זיכויat all.)

CHART!

SALIM BASKETS- Sif 199 and 204: We make distinctions based on those presented in sif 2 and between revach peiruti and הון. Under the CHozeh מסHachnasa it can be broken down into even smaller categories. What this does is create specific categories for which the govah tikra of the זיכויis applied and the tax that must be paid is the higher of the two (foreign tax or Israeli tax on the same amount of income). This serves to defeat the Averaging Method (the averaging method consists of…)of getting around the תקרת זיכוי.

If there was a basket by country, that too would serve to defeat the averaging method for getting around the תקרת זיכוי. See chart for details and numbers.

(CLASS 4)

How can I still get around the salim basket using the averaging method where I would otherwise be limited in my ways of getting around the תקרת זיכוי?

  1. I can set up the active business (more difficult because it involves factories and stuff) where I need more זיכויin countries with lower taxes. This is as opposed to setting up just the passive in places with low tax rates (which is the easy part- just moving money).
  2. MIXER- set up a company that owns companies all over the place that come together somewhere that will average all of the incomes to one place. That one central company will then pay dividends to the Israeli mother company and that would save the mother company from an imposed restriction on the averaging method.

-This only makes sense in the context of זיכויakif. For זיכויakif there is no salim baskets so all I have to do is set up the subsidiary abroad and I get tax benefits as if there is nothing preventing the averaging method.

זיכויAkif is a way of preventing a situation of double taxation where a parent company in Israel gets dividends from a subsidiary abroad and that subsidiary paid taxes to the foreign country on the money before dividends were paid out and the parent company must then pay tax to Israel on the dividends that it received. So זיכויakif is a way of getting a זיכויon taxes paid by a subsidiary. (If the subsidiary earned 1000, paid taxes 300, gave the parent 700 and the tax rate in Israel is 40% then the parent would only have to pay an additional 100.)

So you can use this method of mixer to get a זיכויakif to get around the limitations of the salim baskets by having your subsidiary mix income from places with higher and lower tax rates and you get a זיכויon everything that does not differentiate between baskets.

Tax deferral- being able to control the time at which you will pay tax. This can be very useful in circumstances of different tax rates in different countries (sometimes).

Go to charts

Bermuda Sandwich- a way to get a tax deferral.

Go to charts

The corporation that is set up in Bermuda is a CFC (controlled foreign corporation) or in Hebrew CHNA”Z (chevra nishletet zara).

The CFC in Israeli law is dealt with in sif 75b2(1): a baal shlita in a CFC that has profits that are not paid out to the investors as dividends are seen as if received to the portion that he would have received had it been paid (this means that there is no reason to keep the money in the company but rather to pay it out as dividends to the baalei shlita). This means that that money will get taxed at this stage and you cannot do tax deferral.

In practice the law is very specific and this specificity gives way for loopholes.

Definition of CFC:

1. Not sold on bursa.

2. Most of the profits are passive (more liberal definition of what is passive).

3. That company is a resident of a country with a tax rate of less than 20%.

4. More then 50% control is directly or indirectly in the hands of Israeli residents. Shlita for this purpose is the power to tell people to do things in the company- this is a very wide definition of shlita. In sif 74B(a)(1)(3)(2) it says that indirect control (holding company that holds company that holds company that holds company…)we examine each stage to see if at that stage there is greater than 50% control as that is a necessity, and if that exists then the shlita requirement is fulfilled.

5. Even on the profits earned we only do this to the passive profits (and not the active profit).

Also, when you pretend that you received a dividend you get to deduct what the other country would have charged you in taxes had you taken the dividend at that point.

(CLASS 5)

What loopholes are created by this definition of CFC?

  1. It only applies to a baal shlita (+10% ownership).
  2. If the company is less then 50% held by Israelis. (I team up with a French company and US company and then we each have 33% ownership and if they have the same regulations then they too are saved from this tax regulation.)
  3. If most of the income is active then this does not apply (if I want to do this I make sure to link it to a company that has a lot of active income.)
  4. This only applies to passive and not active profits. (so make whatever you can look active).
  5. This also entails a “זיכויraayoni” on what I would have paid the foreign country in tax. (what this means that if there is a high tax on dividends but lower tax on domestic returns then it makes sense to continuously defer.)

What are ways that one can avoid becoming a CFC?

  1. If I am selling things to chul then I should have an Israeli company that produces the thing and a separate foreign company that markets the thing and have all the profits in the marketing company (this can be done by selling the marketing company the things at cost) and this profit can be deferred over and over because it actually is from an active source so it is not a CFC.
  2. I can have many investors each of which have less then 10%. In the United States the way they did this was mutual funds. Then the US law was changed to catch the mutual funds. The similar Israeli law was not amended (so we see that the Israeli law does not really want to catch them.)

חמי"ז= “chevra mishlach yad zara” is:

  1. Owned by no more than 5 people, the public has no interest in the company, and it is not a subsidiary. (sif 76)
  2. Less than 75% of it is under the control of Israeli residents
  3. The baalei shlita or relatives work for the company in one way or another.
  4. The majority of that company’s income comes from the field of expertise of the company.

If I were to make money abroad in my line of work I would have to pay Israeli income taxes on that money just like any other Israeli income. If I want to avoid that then I should set up a foreign company that offers that type of service that I am an employee of (???without that company falling under the definition of chami”z???).

Sif 75B (5)(a)- deals with it differently then CFC because it views the money as if earned in Israel itself. So you need a special sif to allow זיכויfor the taxes paid abroad.