On January 1st, 2012 a new, precedent-setting judgment was handed down in the Tel Aviv District Court by The Hon. Justice M. Altuvia on the matter of international taxation. Pursuant to the judgment, a foreign company, which was incorporated in the Bahamas, is classified as an “Israeli citizen” for tax purposes, in light of the determination that the control and management of its business are activated from Israel.

As a rule, pursuant to the Income Tax Ordinance in Israel, a company is deemed to be “an Israeli citizen” for taxation purposes when one of the following aspects is true for it: a. The company was incorporated in Israel or – b. The control and management of its business is activated in Israel (hereinafter – “The Control and Management Test”).

We stress that, commencing from Amendment 168 to the Ordinance (passed on September 9th, 2008), a foreign company shall not be deemed to be “an Israeli citizen” for the purposes of the Income Tax Ordinance, for 10 years from the date that it became an Israeli citizen, if the control and management of its business are activated in Israel by a new immigrant or returning Israeli citizen.

The question of “control and management” was first debated for the purposes of income tax in Israel in the Niago judgment.

In the judgment, reference is to a foreign company that was established in 1990 in the Bahamas (hereinafter – “the foreign company”) to which activity was transferred from an Israeli company, relating to contacts with customers outside of Israel.

In 1993, an Israeli company (under similar ownership) acquired the activities of the foreign company as a part of its organization for an issue on the TASE. In consideration, the foreign company received a sum of $7.8 million, which it distributed amongst its Israeli shareholders as a dividend – tax-exempt.

Inter alia, the assessment clerk claimed that the dividend that the Israeli shareholders received is taxable, because the reference is to a company in which the management and control of its business is activated from Israel. Consequently, he argued, that reference is to a company that is an Israeli citizen for income tax purposes.

The appellants claimed that reference is to a foreign company that is not controlled and managed in Israel, inter alia because: The directors in the foreign company are not Israeli citizens; the Board of Directors meetings took place outside of Israel; the Board’s decisions were taken independently by the foreign directors without any intervention by the Israeli shareholders; the foreign directors were knowledgeable in various relevant fields for the foreign company’s activities; the regular management of the foreign company was conducted outside of Israel; the foreign company’s head office was located in Geneva and the foreign company had additional offices in Amsterdam and New York; the concentration of orders placed throughout the world, the financial management, issue of invoices and receipt of letters of credit were executed from the foreign company’s offices.

The assessment clerk objected to this and claimed that the company’s actual business was conducted by the Israeli shareholders and their children.

The Tel Aviv District Court, via the Hon. Justice Altuvia dismissed the appeal and determined that, according to the evidence placed before it, the company’s managers and formal employees (that were located outside of Israel) were used as a platform lacking any real business essence and, in actual fact, the decisions at the comprehensive policy level, as well as daily decisions were taken not by them but by the appellants and their representatives.

In view of the aforementioned, the District Court determined that the foreign company must be perceived as one in which “the control and management of its business is activated in Israel” and, consequently, is an “Israeli citizen” company for taxation purposes.

Accordingly, the court determined that the dividend that was distributed to the shareholders is taxable in Israel.

In view of the aforementioned, we recommend a thorough examination of the activities of foreign companies that are owned and/or managed by Israeli citizens in order to adapt its activities to the determinations of the court in the judgment, should this be necessary.

Our offices specialize in legal consultation and accompaniment and company and individual taxation in the high-tech and investment fields in Israel and overseas.

This circular is intended solely for general purposes. The contents of this circular may not be used without receiving professional individual legal opinion and/or advice pursuant to the specific circumstances.

Sincerely and Respectfully,

Lior Pick and Co Law Offices