Dr. Avi Nov, Adv.

April 2010

The Israeli Tax Ordinance Amendment Law (No. 132) introduced the CFC rules taxing undistributed passive income of a controlled foreign corporation (“CFC”) as if it were distributed to Israel resident shareholders holding a controlling interest.

In the event that passive income derived by a CFC is deemed to fall within the scope of the definition of passive income for purposes of CFC legislation, such income may be tax in Israel at the level of the Israeli controlling shareholders at a rate of 25% on a current basis.

Income which would be considered business or professional income under Israeli law would be specifically excluded from the definition of passive income under CFC legislation. This means that CFC taxation should not apply if the majority of income or profit is active, i.e., deriving from a business.

The Israel Tax Authority does not define a “business”, and according to the interpretation of the Israeli tax authority, the activity of a business should be examined, inter alia, by the following characteristics:

(1) The nature of the assets used for the activity – in general, some assets are in their nature assets which are used for a “business activity”, as opposed to assets for investments or capital (such as bonds or real-estate). It has been stated that the nature of the asset must be examined with respect to the particular transaction in question.

(2) Proficiency and skills of the assessee - proficiency and skills of either the assessee or of a person he consults. In principle, if the level of his proficiency and skills is fairly high, the activity in question would likely be regarded as a business activity.

(3) Mechanism of the operations – a business is usually characterized with an ongoing and permanent activity. Therefore, such activity requires a suitable mechanism, i.e., a manager, an office, bookkeeping, active operations etc.

(4) Circumstances of the activity in question and the existence of purpose of profit – this is a general test, according to which the particular circumstances of every activity would be examined, in order to determine the nature of it.

See also: Tax planning: Israeli CFC taxation.

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