During the last several years, the Israeli parliament has made several amendments to Israeli tax laws in an attempt to improve the Israeli corporate tax system and increase tax competitiveness in the global economy. This paper will shed more light on recent amendments to the Law for the Encouragement of Capital Investments, 5719-1959, which aim to achieve enhanced growth in the business sector and in improving the industry's competitiveness in international markets.
Generally speaking, the State of Israel taxes Israeli resident corporations on their worldwide profits and gains, whereas non-resident corporations are subject to tax on their Israeli source profits and gains from the disposition of "Israeli" assets. This is why the definition of corporate residency is very important.
A corporate residency is determined either according to the place of incorporation (e.g., a corporation is deemed to have Israeli residence if it is organized under the laws of Israel) or according to the place in which its management and control is exercised (e.g., a corporation is deemed to be resident in Israel if its operations are managed and controlled from Israel). While this place of incorporation test is relatively straightforward, the management and control test is not as self-evident. Israeli courts have interpreted this test to be comprised of two separate and independent terms: "control" and "management." Accordingly, even if a company is controlled by Israeli shareholders it will not be deemed to have Israeli residence so long as its management is executed outside Israel.
As mentioned above, an Israeli corporation is subject to tax on its worldwide profits and gains at a flat rate (whether such income is ordinary income (e.g. business income, interest, royalties, etc.) or capital gains). In 2011, corporations are generally taxed at a flat rate of 24%. The corporate income tax rate is gradually reduced until it reaches a final rate of 18% in 2016.
When such income is distributed to its shareholders, such distribution is then taxed at the shareholders' level. The dividend income tax rate varies: a 25% rate is levied on dividends paid to a controlling shareholder (i.e., a shareholder that holds 10% or more of the corporation for a period of 12 months before the payment), a 20% rate to a non-controlling shareholder and a zero percent rate when such distribution is made from one resident company to another (assuming both corporations are not viewed as pass-through entities for tax purposes). Moreover, these rates are sometimes reduced under an applicable income tax treaty (i.e., under the U.S.-Israel income tax treaty, the dividend tax rate may be reduced to 12.5% when the distributing entity is not subject to tax relieves under the Law for the Encouragement of Capital Investments, 5719-1959).
Following recent changes in the Law for the Encouragement of Capital Investments, 5719-1959 (which became effective as of January, 2011), a "qualified industrial enterprise" (one that has over 25% of its annual income derived from export) may be subject to a reduced flat corporate tax rate of 15% (and a flat 10% rate for enterprises located in Zone A, which is a development area). Such a lowered corporate tax rate is gradually reduced until it reaches a final rate of 12% in 2015 (and a flat 6% rate for enterprises located in Zone A). In addition, the shareholders of such a qualified industrial enterprise will be entitled to a reduced dividend withholding tax of 15%.
In summary, in addition to the various tax benefits that the recent amendments to the Law for the Encouragement of Capital Investments, 5719-1959 offers, and unlike the previous statute, such reduced rates are not contingent on making an investment and such tax benefits apply with respect to the entire qualified industrial enterprise profits and gains and not only with respect to profits and gains that are allocated to a certain investment/activity. Furthermore, the taxpayer may be entitled to receive governmental grants (assuming it is located in Zone A) in addition to the reduced tax rates.