Before commencing operations within the limits of the state of Israel, many international companies face a dilemma – to establish a subsidiary or to open a branch of the foreign company in Israel.
In this brief article, we will review the relevant considerations and differences relating to this question in an attempt to reach a well-informed consensus on the issue – a “branch” or a “subsidiary” in Israel.
As a general rule, a branch is a foreign company’s representative through which it can manage its business in Israel. Alternatively, there are situations possible in which the Israeli branch is solely a quasi-marketing representative.
In every instance in which a foreign company operates through a branch in Israel, the question as to whether that operation is a permanent establishment or not must be addressed.
A branch does not have any legal rights separate from its owners, as is also true when its business/financial operations are completely separate entities as operations/earnings centers. Consequently, from a legal perspective, a foreign company that operates through a branch in Israel might very easily find itself as a defendant for the branch’s indebtedness (deriving from operations in Israel).
As a rule, the foreign company would be directly indebted and responsible for all of the branch’s debts in Israel (to creditors/taxation authorities etc.), simply because there is no legal separation – no incorporation screen that separates them.
On the other hand, a subsidiary is a separate legal entity in which the shareholders are the foreign company. Consequently, the risk that the foreign company bears relating to it is limited to the level of its investment in the subsidiary in Israel. This rule is rescinded when the operations of a subsidiary of the parent company are conducted in a manner that is likely to give cause to an Israeli court to ignore the aforementioned separation and “raise” the subsidiary’s incorporation screen. Thus, this enables creditors to act against the parent company (the foreign company).
It is worth noting that the courts in Israel are not accustomed to ignoring the incorporation screen as a routine matter and, that, pursuant to the Companies Law, 5759 – 1999 (hereinafter: “the Companies Law”), arduous arguments are required for an Israeli court to do so.
From this aspect, only, there is a preference to incorporate in Israel as a domestic subsidiary.
Introducing a Partner/Selling the Operation in Israel
Incorporation as a subsidiary in Israel enables much more flexibility in everything relating to introducing a partner (domestic or foreign) for that operation and/or in the context of selling the operation in Israel (via selling the Israeli company’s shares or by allotting shares to the subsidiary in Israel). It must be emphasized that, generally, a share allotment will not be a tax event in Israel.
As a rule, an Israeli company is taxable in Israel based off of its earnings at a rate of 24% in 2017 and 23% in 2018), with the exclusion of companies that benefit from tax benefits pursuant to the various encouragement goals such as the Capital Investment Encouragement Law, 5719 – 1959 (hereinafter: “the Capital Investment Encouragement Law.”)
Furthermore, an additional tax of 25% to 30% will generally be paid by distributing the Israeli company’s earnings as a dividend (to the controlling interests – 10% and over), except when the dividend is distributed to an Israeli parent company (under certain conditions), when reference is to a beneficiary enterprise (pursuant to the Capital Investment Encouragement Law – 15%), or when the dividend is distributed to a parent company in a country with a treaty, imparting an alleviation in the taxation rate pursuant to the relevant treaty (for example – Russia – 10%, the US – 12.5% under certain conditions etc.. (
By contrast, an Israeli branch of the foreign company is only taxable in Israel according to the company’s tax rate (i.e. 24% in 2017 and 23% in 2018), without any additional tax burden on the distribution of earnings/a dividend. This is merely a transfer from pocket to pocket (because in any event, the earnings belong to the foreign company, which owns the Israeli branch).
The Appointment of a “Representative” for Tax Purposes
Section 60 of the Value Added Tax Law, 5736 – 1975 (hereinafter: “the VAT Law”) mandates a representative, appointed by the foreign citizens, to manage businesses in Israel through foreign corporations. Pursuant to Section 60, a burden is imposed on a foreign dealer to inform the VAT manager the name of his local representative within 60 days of the date of commencing business operations in Israel. The representative could be either an individual whose permanent residence is in Israel or a corporation registered in Israel [see Regulation 6 of the Value Added Tax Regulations (Registration) 5736 – 1976.
As aforementioned, Section 60 arranges the matter of registering a foreign business’s operations in Israel and determines that a representative appointed for the purposes of the VAT Law is treated as if taxable. Consequently, the extent of the responsibility imposed on the representative can be understood.
It should be noted that, as a part of Amendment 132 of the Income Tax Order [New Version] (hereinafter: “the ordinance”), Section 68b, which determines that a foreign citizen is required to appoint a representative pursuant to Section 60 of the VAT Law, the requirement to appoint a representative also for the ordinance’s purposes, was added. The foreign citizen’s representative shall be empowered to file reports to the taxation authorities, in order to receive money for the foreign citizen and to handle any pertinent matter pursuant to the law in Israel.
Section 346 of the Companies Law obligates all foreign corporations with business operations in Israel to be registered at the Registrar of Companies as a foreign corporation operating in Israel. Furthermore, activity in Israel obligates opening files and registering with the taxation authorities in Israel [(VAT, income tax, National Insurance and income tax (deductions)] prior to commencing the aforementioned business operations.
From the moment of its incorporation and commencement of operations in Israel, an Israeli subsidiary must also be registered and open the aforementioned files at the taxation authorities in Israel, similarly to operations through a branch.
As a rule, establishing an Israeli company domestically is a simple and swift procedure.
Registering a foreign company’s branch in Israel, on the other hand, is likely to be slightly slower, but still simple and relatively quick.
On the other hand, the procedure for opening a bank account in Israel for a foreign company’s Israeli operating branch is a little more complex than opening a bank account for a local Israeli company.
It should be emphasized that registration and opening files at the taxation authorities cannot be executed prior to the company’s opening of a bank account in Israel. Consequently, a company or branch that has not yet opened a bank account or been registered at the taxation authorities in Israel, is not entitled to commence any business operations in Israel.
Business activity not in compliance with the aforementioned regulations is a criminal offense.
From taxation considerations, operating in Israel will almost certainly be more worthwhile when operating as a foreign company’s branch. On the other hand, from the aspects of efficiency, simplicity and legal protection, it would appear that operating as an established domestic Israeli company, would be greater.
The forenamed should not be perceived as a recommendation and/or expression of opinion. In all instances, we recommend receiving professionally individualized advice by the concrete circumstances of each and every event.
We would be happy to be at your disposal for any queries and or explanations regarding this matter, or in general.
Lior Pick & Co. Legal Offices
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