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gains tax over the sale of shares in Israeli companies, if the capital gains are not
derived from the operation of its permanent establishment in Israel. It is important
to note that those exemptions may not apply where the majority of the company’s
assets consist of real estate or natural resources. Additionally, at this time, Israel is
a party to more than 50 bilateral treaties which provide various forms of tax relief to
foreign residents.
The Law for Encouragement of Capital Investments
Israel supports capital investment initiatives by developing and granting a wide
range of incentives and tax benefits. These tools are designed to boost productivity
in certain industrial sectors, encourage exports, increase Israel’s overall economic
revenues and promote its overall growth. To attain these goals, Israel has passed a
number of laws such as the Law for Encouragement of Capital Investments (“the
Encouragement Law”).
The Encouragement Law went through several changes in recent years in an effort to
redesign its provisions so that it will attract investors on the one hand, and it will be
simplified to contribute to achieving its various goals on the other. The amendment
also contained a moderate increase to the tax rate to be imposed on benefited
enterprises following the application of the Encouragement Law’s benefits. Today,
the law includes two corporate tax rates: 9% for investment in certain rural areas the
government wants to prioritize and 16% for other geographic areas. In addition, the
withholding tax rate for benefited individuals is 20%, instead of the withholding tax
rate applicable otherwise (25-30%).
It should be noted that recently, a new inter-ministerial committee has reexamined
the provisions of the Encouragement Law and its recommendations may trigger
additional amendments.
The Expected Change to Digital Financial Activities
According to existing law, a foreign corporation’s income is only taxable if it has been
produced in Israel. If the foreign corporation is from a treaty country, the corporation
must have a “permanent establishment” in Israel for its income to be taxable.
In light of the tremendous proliferation of financial activities via the internet and taking
into account the OECD and G-20 efforts to address the international tax challenges
of the digital economy, the ITA sought to redefine some of the key concepts of our
tax regime, and published a draft of a “game changing” circular explaining its views
regarding the taxation of income produced from services provided online. The draft
expands the definition of a “permanent establishment” so that it might apply to a
business if the core of its financial activity is via the internet, regardless of the physical
location of its server. In determining whether such a corporation has a “permanent
establishment”, the ITA will consider indications such as the adequacy of the internet
website to Israeli users (its language, style, currency, etc.); its use to connect Israeli
consumers with Israeli suppliers; its popularity with Israeli consumers; whether the
foreign corporation is exposed to business risks in Israel; and so forth.
Regarding VAT liability, a foreign corporation might be required to register as a licensed
dealer and its transactions might be subject to VAT, if its internet activity has tight and
direct ties to Israeli clients.
The draft, with its far-reaching applications, is now open for public comments, and
may be amended adequately.