Section 75(B) of the Israeli Income Tax Ordinance imposes a tax on the undistributed passive income of a controlled foreign corporation (“CFC”) as if it were distributed to Israel resident shareholders holding a controlling interest. Undistributed passive income will be taxed as a deemed dividend at a rate of 25%.
A "Controlled Foreign Corporation" is defined as a non-Israeli company, which meets all of the following conditions:
Its shares are not registered for trade; or if only partially registered, less than 30% of its shares are offered to the public;
The majority of its income or the majority of its profits in a tax year derive from passive income;
The passive income is subject to tax in the foreign country at a rate which does not exceed 20%; and
In excess of 50% in one or more of the means of control of the company are owned, directly or indirectly by Israel residents.
In this context, “means of control” includes: (i) the right to participate in the profits of the foreign resident company; (ii) the right to appoint a director to the foreign resident company; (iii) voting rights; (iv) the right to receive a portion of the balance of assets of the foreign resident company upon winding-up; and (v) the right to direct a person vested with one of the rights referred to in (i)–(iv) above as to how such right may be exercised;
Passive income is defined as income from any of the following sources which would not constitute income from business or a profession under Israeli tax law if accrued or derived in Israel:
Interest or exchange income;
Capital gain from the sale of an asset (excluding the sale of an asset which the company used in its business or profession);
Business income derived indirectly from a source of income listed in Section 75B(a)(5) of the Israeli Tax Ordinance.
For purposes of taxation of the controlling shareholders of a CFC, "undistributed income" will include the CFC's passive income, as defined above. Undistributed profit is defined as "profit from the CFC's passive income derived in the tax year… which was not paid to the beneficial owner over the course of that year”
The controlling member of a CFC shall be deemed to receive his proportional share of the unpaid profits of the CFC as a Deemed Dividend;
Calculations of passive income for CFC purposes would be calculated as follows:
With regards to income attributable to treaty countries (provided the company is a resident of the treaty country and files tax returns in that country) income and profit amounts would be calculated in accordance to the domestic tax law of the treaty country. In other circumstances, calculation would be conducted according to generally acceptable accounting principles.
Upon taxation of CFC income, a deemed credit will be granted. This so-called deemed credit will be granted in the amount of the foreign tax (including withholding tax) which would apply abroad at the time of the effective distribution of dividend, even if dividend is not actually distributed.