Israeli tax implications - changes in business model
Dr. Avi Nov, Adv.
The Israel Tax Authority issued on 8 July 2010 a position paper on the tax implications resulting from a change in the business model of Israeli companies and, in particular, technology companies.
The Israel Tax Authority position paper indicates that such transactions will be subject to examination. The paper instructs assessing officers to discover whether a change in business model has taken place, and if so, to ensure that tax due to Israel is collected.
There are series of steps, as described below, the tax assessing officers would take to determine whether there has been a change in the business model and, if so, he will determine the Israeli company’s tax liability arising as a result of a change in business model.
In a classic change in business model, the rights in the IP assets are transferred by an Israeli company, in whole or in part, to a foreign related company that becomes the “owner” of the rights. The Israeli company then becomes a service provider, engaging in R&D activities on behalf of the related company for which it is remunerated for its costs, plus a certain margin (typically cost+10).
According to the Israel Tax Authority position paper, a change in business model is usually effected through a restructuring of a group of companies. Further indicators include, inter alia a reducing the number of Israeli employees and decrease in the cash flow of the Israeli company.
According to the Israel Tax Authority position paper, a change in a business model may trigger taxable events, as follows:
(1) A transfer of intangible assets is liable to Israeli capital gains tax. According to the Israeli Income Tax Ordinance, a sale includes any action or event which results in an asset leaving the possession of a person. At present, the tax rate is 25%.
(2) If any intangible assets is used by another company (no sale), the Israel Tax Authority asserts that the other company should pay an arm’s length royalty for the use of the intangible assets.
(3) If assets are transferred out of Israel, the process may be classified as an in-kind dividend distribution to the company’s shareholders and taxed in Israel. At present, the tax rate (subject to any tax treaty) is 20% to a shareholder who holds under 10% of the company or 25% tax if the shareholder holds 10% or more.
(4) If the Israeli company was an approved enterprise, which elected an exemption from company tax on undistributed profits, deeming a dividend will trigger company tax on those profits at rates of up to 25%.
(5) The Israel Tax Authority has the power to disregard transactions that are artificial or fictitious and aimed at achieving an improper reduction of tax. The Israel Tax Authority is also considering making a change in the business model a reportable tax planning event.
Instructions to assessing officers
The Israel Tax Authority position paper sets out guidelines to assist the tax assessing officer to determine whether there has been a change in business model that triggers taxable events, as follows:
1. Information in the tax return documents on related party transactions;
2. Direct or indirect restructuring of holdings;
3. Change in the method of intercompany accounting;
4. Change in a company’s operations;
5. Service support for its products to a company that merely provides R&D services;
6. Change in the ownership of intangible assets;
7. Significant workforce reductions in particular departments, like in production;
8. Reduction in the Israeli company’s total revenue/turnover;
9. Material changes to gross and operating profits;
10. Reduction in the cash flow of the Israeli company or in deferred revenue from sales and/or ancillary services and/or support.
The Israel Tax Authority position paper empowers assessing officer to tax certain changes in business model of Israeli companies. Taxpayers are advised to take steps to determine, in advance, the tax implications of any such changes.
Dr. Avi Nov, Adv., is an expert in Israeli & international tax law