Israeli Tax implications of investing via a US LLC

Dr. Avi Nov, Adv.

April 2009

A Limited Liability Company (LLC) is an important investment vehicle for Israelis who operate in the US. An LLC is a company incorporated under the laws of one of the US states. In practice, LLC’s are often formed in the state of Delaware for administrative ease. They are relatively cheap to form and run. An LLC does not have shareholders, but rather members.

According to US tax law, an LLC may be considered as a pass-thru entity whose income is taxed at the individual level. However, the tax status of an LLC is not clear in Israel tax law. For Israeli investors, it is important to take this into account, together with other various tax planning considerations, especially tax credit entitlement, before operating via an LLC.

The advantages of an LLC

An LLC is treated as a transparent entity for US tax purposes, which means that it is disregarded for US tax purposes. Consequently, the LLC’s owners may be assessable individually based on their tax status, if any, in the US.

The members of an LLC should not be taxable in the US if the owners are not US residents, US citizens, nor US green card holders, provided that the LLC conducts no business in the US and derives no income in the US. This makes an LLC potentially an offshore vehicle for Israeli members who invest outside the US and Israel.

An LLC will generally afford limited liability legal protection to its members.

However, it should be noted that members of an LLC who are Israeli residents would be subject to US estate tax on the value of any assets held in the US.

Israeli Tax Implications

The anticipated Israeli tax consequences depend on whether the LLC's income remains in the LLC or is distributed, partly or fully, as dividends.

To the extent that the LLC's income remains in the LLC, there may arguably be no Israeli tax on income of the LLC, assuming all of the following, amongst other things:

(1) If the LLC is not a Foreign Professional Company. This involves reviewing the activities and ownership of the LLC carefully. Otherwise regular Israeli corporate tax applies to the LLC.

(2) If the LLC is not controlled and managed from Israel. The LLC should have one or more US resident directors (not Israeli residents). Otherwise regular Israeli corporate tax will apply to the LLC.

(3) The LLC is not a Controlled Foreign Corporation (CFC) for Israeli tax purposes. If the LLC's income accumulates as cash or other passive assets (investments etc.) to a point that the LLC can be considered a passive company, Israeli CFC legislation may deem an annual dividend to be taxable in Israel.

Israeli tax Authority Circular

According to an Israeli Income Tax Authority (ITA) Circular 3/2002 dated February 18, 2002, an LLC would be viewed as a body of persons as defined in Section 1 of the Israeli Tax Ordinance. However, the Circular does not address the question whether an LLC is a company.

According to the Circular the LLC could be challenged as either controlled and managed in Israel, or an artificial transaction according to Section 86, dealing with artificial transaction in Israel tax law.

According to Section 86 of the ITO, a certain transaction may be considered artificial by the ITA, if carried out mainly for the improper avoidance of tax, and consequently the transaction may be disregarded. Therefore the incorporation of an LLC may be disregarded and the Israeli owner may be seen as directly deriving income instead of the LLC, for Israeli tax purposes.

Furthermore, the Circular states that an LLC would not be subject to treaty protection according to the Israel US tax treaty.

A second Israeli tax Circular number 5/2004 dated April 19, 2004, allows an Israeli member to elect for the LLC to be transparent for foreign tax credit purposes but not for other purposes, such as losses. Therefore, an individual Israeli resident taxpayer can choose to pay tax income derived via an LLC by either 25% Israeli tax on any distribution with no foreign tax credit (no transparency election) or personal Israeli tax with foreign tax credit (transparency election).
 
Dr. Avi Nov Law Offices, Israeli & international tax law 

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*This article is intended for informative purposes only and is in no way to be construed as tax advice or a legal opinion 
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