Global Tax Alert | 25 November 2013

Israel moves forward with CFC amendments and cancels personal income tax rate increase

  • Share

This Alert provides a summary of two Israeli tax developments which occurred in November 2013:

  • The Israeli tax Parliament Finance Committee has approved certain amendments to the Israeli anti-deferral regime (Controlled Foreign Corporation – CFC). The main changes proposed are set out below.
  • The Israeli Minister of Finance, Mr. Yair Lapid announced the cancelation of the scheduled increase of personal income tax rates.

The proposed amendments will be submitted to the Israeli Parliament in order to complete the legislative process, and they will become effective as of 1 January 2014.

CFC Amendments

Background

The Israeli CFC rules were introduced into tax legislation in 2003 to counteract the deferral of taxation of passive income until actual distribution to Israel. An Israeli resident that holds 10% or more of the shares of a CFC is subject to tax in Israel on a deemed dividend corresponding to their share of the undistributed passive income of the CFC (on the last day of the tax year). The CFC tests are applied for each tax year and the CFC classification is reported on Form 150 attached to the annual tax return.

The proposed amendments were drafted in order to close some loopholes in the current legislation and to update the effective tax rate test.

Proposed amendments

1. CFC definition

One of the five cumulative tests that are applied in determining whether a foreign company constitutes a CFC is the effective tax rate test. Under the proposed amendments, the effective tax rate test will be satisfied if the foreign company’s passive income is subject to an effective tax rate of not more than 15% (instead of 20% under the current regime).

2. Passive income definition

A new presumption has been proposed, according to which any consideration received from a sale of securities will constitute passive income (even if the sale is in the course of trade or business).

3. Deemed foreign tax credit

It is proposed to abolish the possibility to claim a deemed foreign tax credit, on the statuary or treaty dividend withholding tax, which would have been imposed upon actual distribution of a dividend by the CFC to the Israeli shareholder.

4. Quantification of income and profits

The current legislation states that where a CFC is resident in a country with which Israel has a double tax treaty, it is necessary to consider local income tax laws in order to quantify the passive income/ profits. Where the foreign company is not a resident of a ”treaty country,” the passive income/ profits are calculated in accordance with Israeli GAAP.

With respect to treaty countries, the proposed amendments clarify that income from participations should be taken into account, even if they are exempt from tax (under a local participation exemption regime) or excluded from the foreign tax base. The amendment also stipulates that notional tax deductions which were claimed for local tax purposes should be disregarded for the quantification of the passive income.

With respect to non-treaty countries, it is proposed that the CFC’s passive income be quantified based on the Israeli tax law instead of using Israeli GAAP.

Personal income tax rates

In accordance with the Israeli Budget Law for fiscal years 2013-214, the personal income tax rates applicable to individuals were supposed to increase for most of the brackets. Based on the recent declaration of the Israeli Minister of Finance, these scheduled increases in the tax rates will be eliminated. Accordingly, the tax rates shall remain as follows:

Tax brackets applicable to income from personal exertion or to taxable income derived by a taxpayer who reached age 60

Bracket

Rate (%)

First bracket rate

10

Second bracket rate

14

Third bracket rate

21

Forth bracket rate

31

Fifth bracket rate

34

Sixth bracket rate

48

Tax brackets applicable to other personal income

First bracket rate

31

Second bracket rate

34

Third bracket rate

48

For additional information with respect to this Alert, please contact the following:

Kost Forer Gabbay & Kasierer, Tel Aviv
  • Sharon Shulman
    +972 3 5687485
    sharon.shulman@il.ey.com
Ernst & Young LLP, Israeli Tax Desk, New York
  • Ram Gargir
    +1 212 773 1984
    ram.gargir@ey.com

EYG no. CM3988