IN GENERAL

The State of Israel taxes Israeli resident corporations on their worldwide profits and gains, whereas non-resident corporations are subject to tax by the State of Israel only on their Israeli source profits and/or gains from the disposition of "Israeli" assets.

“Corporate residency” is determined either according to the place of incorporation (i.e., a corporation is deemed to be Israeli resident if it is organized under the laws of Israel) or according to the place in which its management and control are exercised (i.e., a corporation is deemed to be resident in Israel if its operations are managed and controlled from Israel). While the place of incorporation test is straightforward, the management and control test is not as self evident. The courts in Israel have interpreted this test to be comprised of two separate and independent terms, both of which must be satisfied: "control" and "management." Therefore, even if a company is controlled by Israeli shareholders, as long as its management is conducted outside of the country, it will not be deemed to be an Israeli resident.

The basic corporate income tax rate is currently set at a 24% 1. When such income is distributed to the shareholders it is taxed again at the shareholders' level (while corporate income tax is levied on the company, the dividend income tax is collected and remitted by the corporation on behalf of the shareholder). 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 during any day in the 12 month period 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 (both corporations are not viewed as passthrough entities for tax purposes. 2)

PARTICIPATION EXEMPTION

Israel has adopted the participation exemption regime, according to which Israeli holding companies that mainly invest in foreign companies are generally exempt from tax on corporate distributions received from qualified foreign subsidiaries, from gains that derive from the sale of such subsidiaries, and from interest income that derives from investments in the Israeli capital market. Moreover, pursuant to the participation exemption regime, corporate distributions to foreign shareholders by the holding company are subject to a 5% withholding tax whereas corporate distributions to Israeli shareholders are subject to 20%/25% withholding tax.

CAPITAL GAINS TAX

Capital gains tax is imposed on the disposal of fixed and intangible assets where the disposal price is in excess of the depreciated cost for tax purposes. Capital gains are divided as follows: Inflationary gain that accrued until 1994; and Real gain – the difference between the total capital gain and the Inflationary gain. The Inflationary gain has been exempt from taxes since January 1994 and subject to 10% tax on the accrued portion until then. The tax rate on Real gains is 20%/25% for individuals and 24% for companies. 3

WITHHOLDING TAXES

Payments by an Israeli taxpayer to a foreign taxpayer may be subject to withholding tax at different rates: (i) corporate distributions are generally subject to a 20%/25% depending on the status of the shareholder (controlling/noncontrolling shareholder); (ii) interest payments are generally subject to a 15%/20%/25% withholding tax depending on the nature of the financial instrument; and (iii) royalties are generally subject to a 25% withholding tax. These rates are reduced under the U.S.-Israel tax treaty; for example, with respect to corporate distributions a 12.5% or 15% withholding tax is levied, depending whether the entity is subject to tax relief under the Law for the Encouragement of Capital Investments, 5711-1959 (which became effective as of January 1, 2011).

GOVERNMENT INCENTIVES

The Israeli Government provides various incentives to encourage economic development, one of which is reduced tax liability pursuant to the Law for the Encouragement of Capital Investments. A "qualified industrial Enterprise" (that has over 25% of its annual income derived from profits) may be entitled to a reduced corporate income tax rate and its shareholders may be entitled to a reduced dividend tax rate. Accordingly, the tax rates for a qualified Industrial Enterprise will be set at a flat 15% rate (and a flat 10% rate for enterprises located in Zone A which is a development area). The reduced corporate income tax rate is gradually reduced until it reaches a final rate of a flat 12% in 2015 (and a flat 6% rate for enterprises located in Zone A.) 4 In addition to the various tax benefits the government provides significant grants.

Another relatively recent governmental incentive focuses specifically on the financial institutions industry. The new initiative (since 2010) calls for the provision of incentives for the establishment in Israel of financial R&D centers by multinational financial corporations. In general, the levels of government support within the framework of this program are 40% of total budget approved by the Research Committee for projects to be executed in the first and second years, 30% for the third and forth years and a level of 25% for the fifth year. Projects executed in the Periphery will enjoy support levels of 50% for the first and second years, 40% for the third and forth years and 35% for the fifth year. In March Barclays Capital declared that it will establish a research and development center in Israel to support the investment bank's global operations.

DOUBLE INCOME TAX TREATY NETWORK (DTT)

To date, Israel has entered into treaties for the prevention of double taxation with approximately 50 countries. Most of Israel's DTTs are based on the OECD Model Convention, according to which commercial and industrial profits are taxed only where attributable to a permanent establishment, and passive income is generally subject to reduced withholding tax rates in the source country. Royalties are generally taxed both in the source country and the residence country. All DTTS contain provisions regarding exchange of information as well as mutual agreement procedures.

The United States – Israel DTT, which entered into force on January 1, 1995, provides a reduced income tax rate (12.5% when the distributing entity is not subject to tax relief under the law for the encouragement of capital investments, and 15% if it is subject).5

TRANSFER PRICING

Israel adopted transfer pricing rules based on the OECD guidelines, according to which transactions between an Israeli resident and its related nonresident would be subject to the transfer pricing regime. The preference is for transaction based methods (other than profit based), with a required detailed transfer pricing study. Please note that Israel has not adopted, as of yet, thin capitalization rules.

CONTROLLED FOREIGN CORPORATIONS (CFC) RULES

Israel adopted the CFC regime, according to which a foreign company controlled by "Israeli 10% shareholders" which mainly generates passive type income and is taxed at a rate lower than 20% would be viewed as if it distributed its passive income to its "Israeli 10% shareholders".

IMPORT DUTY AND PURCHASE TAX

Duties and purchase tax are imposed upon imports mainly at percentage of the value of the goods, in order to protect domestic markets and promote fiscal policies. Israeli importers with the U.S.A. and European Common Market countries benefit from bilateral duty free agreements. Reductions in purchase tax on imports are also available to companies producing in Israel for export.

PERSONAL INCOME TAX

Progressive tax rates in 2011 for individuals vary from 10% to 45%.6

VALUE ADDED TAX

Value Added Tax is imposed in Israel on a sale or the provision of a service in Israel if the sale/transaction has a commercial character. The rate of VAT in Israel is currently 16% (November 2011). Some transactions are subject to VAT at the rate of 0%, such as: (a) exported goods; (b) fresh fruit and vegetables; (c) air hotel services and car rentals to tourists who pay in foreign currency; (d) sale of intangible assets to nonresidents; (e) transportation of cargo and passengers to and from Israel; (f) sale of goods and services to the Eilat free-trade zone; and (g) insurance premiums.

SOCIAL SECURITY

Social Security and Medicare (national insurance) applies to the income of both the employees and the self-employers. The rate of the monthly advance payment for a self-employed person amounts to a maximum of 17.9% on a maximum monthly income of NIS 73,422.