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Guidelines. The circular provides an exemption from
preparing a transfer pricing study where specific
prices/rates are being applied (in the example above,
a price for an LRD with 3% to 4% Return on Sales
will be accepted by the ITA without presenting a
study). As per the later circular (i.e., transfer pricing
aspects following a business restructuring), the
ITA automatically views any transfer of FAR as a
business restructuring that must adhere to the arm’s
length principal. This subject is still in dispute among
experts in the field. Furthermore, it is worthwhile to
note that the ITA circulars express the ITA opinion,
but they do not bind the taxpayers.
A fourth circular depicts the ITA’s interpreta-
tion on intercompany loan treatment. According to
the ITO, a loan that was given by an Israeli compa-
ny to its foreign controlled subsidiary is excluded
from the arm’s length principal as long as the loan
meets certain conditions, including: not bearing
interest and linkage differential, having at least
a 5-year maturity and it is subordinated to other
debts. The circular clarifies the provision’s con-
ditions, and its applicability when parties to the
transaction are reversed (i.e., when a loan is given
by a foreign company to its related, controlled Is-
raeli company).
FOREIGN TAX-”TRANSPARENT” ENTITIES
Tax Reliefs and ITA Circular:
In general, a foreign
entity with the characteristics of a corporation, will
be treated as a company for Israeli tax purposes
and therefore will be liable for tax at the corporate
level, even though it is considered a “transparent
entity” for tax purposes in its place of residence.
For example, US LLCs and S Corporations are
generally treated as corporations for tax purposes
in Israel. Further, from an Israeli tax perspective,
the taxation of an LLC’s Israeli interest holders is
neither regulated nor clear. Notwithstanding the
above, according to an Israeli tax circular published
by the ITA in 2004, in certain circumstances there
is a special tax mechanism applicable with respect
to foreign tax credits of an Israeli tax resident who
holds interest in a US LLC which is treated in the
US as a pass-through entity. The circular allows the
Israeli taxpayer to elect to look through the LLC
for Israeli tax purposes and to therefore attribute
the LLC’s taxable income to the Israeli interest
holder; however, this is done only for the purpose of
allowing the shareholder to receive a tax credit in
Israel for taxes paid in the US. The circular explicitly
states that it is limited only to foreign tax credits,
and does not regard the LLC as a flow-through
entity for all tax purposes. The aforementioned
discussion raises other consequences, such as:
LLC classification as a controlled foreign company
(CFC), LLC’s tax residence classification using the
management and control status, etc.
Israel District Court Ruling:
During 2017 the Israel
District Court published a ruling which sheds some
light and elaborates on the taxation in Israel of a
US LLC, which is regarded as a pass-through entity
from a US tax perspective. The court decision
validated the content of the ITA Circular from
2004, and ruled that the classification of a foreign
corporation with respect to its taxation in Israel
shall be in accordance with the tax laws of Israel.
Meaning, even in cases where a corporation is
regarded as a pass-through entity in another
country, it should be treated as an opaque entity
from an Israeli tax perspective. This means that
an Israeli tax resident who holds interests in the
LLC shall not be entitled to tax credit in Israel on
the taxes paid in the US on the LLC’s income if such
income is treated as a dividend in Israel.
In a district court ruling, published recently, the
court decision emphasises once again the circular
approach that for Israeli tax purposes LLC is con-
sidered as a pass-through entity only for tax credit,
and therefore a shareholder of several LLCs cannot
offset LLCs’ losses against different LLCs’ profits.
The LLCs’ losses and profits do not pass-through
to the individual and should be treated within the
LLCs as separate opaque entities.
CORPORATE MERGERS AND DIVISIONS
In general, according to the provisions of the
ITO, mergers, splits, transfers of assets and
shares transfers within a group of companies
are considered taxable events under the ITO
provisions. However, a tax deferral may be granted,
provided certain conditions are met. In recent
years there have been a few legislative changes
allowing companies to ease the process of their
restructuring. In this respect, it is worthwhile
mentioning the shortening of the “Required
Period” (in which the participating shareholders