Rimon Law Blog

If you are a company with operations in both the United States and Israel, you should be aware of several very important U.S. and Israeli Tax issues when you engage in cross border operations. I have set forth below several of the main issues. This list is not exhaustive and only reflects briefly the main tax issues. Other issues such as employment, banking, intellectual property rights, custom duties etc. will be addressed in other communications.

A. U.S. TAX ISSUES

1. U.S. Distributor

The use of a distributor or agent should not subject the Israeli company to U.S. tax unless such business is conducted through a so-called permanent establishment.

Whether a distributor is deemed to be a permanent establishment for the Israeli company in the United States should be examined under domestic U.S law and under the U.S./Israel Income Tax Treaty.

In general, a U.S. distributor can be deemed to be a permanent establishment of a foreign entity if it is not independent of the foreign entity and/or can sign contracts on behalf of the foreign entity.

2. Sales and Use Tax

A U.S. entity of an Israeli company may have to charge sales tax to its customers if it has nexus where it is located. Nexus can be created if a business maintains a presence of people or property in a given jurisdiction. Sales tax rates and exemptions differ per state.

3. Tax Administration
A U.S entity will be subject to filing different tax returns such as federal tax returns (Form 1120: U.S. corporate income tax return) and state tax returns (e.g., Form 100: California Corporation Franchise or Income Tax Return). If doing business in several states, the U.S. entity might have to file in different jurisdictions.

4. Foreign Tax Credits
If a U.S. company earns income in Israel, that income is taxable in the United States and may be taxable in Israel as well. Therefore the United States allows the U.S. company to offset taxes due in the United States with the income taxes paid in Israel. However, since the United States only provides a foreign tax credit for foreign income taxes imposed on what the United States considers to be foreign source income, the U.S. sourcing rules are very important and require the U.S. company to maximize the foreign source income to allow a maximum foreign tax credit
5. Foreign Currency Transactions
The U.S. Tax code has several sets of rules for the treatment of gains and losses arising out of currency transactions, which can arise (e.g., as a result of the acquisition and disposition of foreign currency, lending and borrowing of foreign currency and foreign transactions).

B. ISRAELI TAX ISSUES

1. Grants, Tax and R&D Incentives

The Law for Encouragement of Capital Investment features two types of benefits. The first is a package of grants and tax reductions, administered by the Investment Center at the Ministry of Industry, Trade and Employment. The second is the Automatic Tax Benefits Program administered by the Tax Authority.

There are several conditions in order to qualify for the grants and tax reductions. The scale of benefits depends on the location and size of the investment.

The Office of the Chief Scientist (OCS) is responsible for promoting industrial research and development. There are various incentive schemes available through the OCS.

2. Corporate Taxation

A corporation will be deemed to be resident in Israel if its activities are managed and controlled from Israel or if it is organized under the laws of the State of Israel. The basic rate of company tax is 26% in 2009, to be reduced to 25% as from 2010 and onwards. A recent proposal under the 2009-2020 Israeli Budget even calls for reducing the company tax rate to 18% by 2016.

Business losses may be offset against income from any source in the same year. Losses may be carried forward indefinitely from one income year to another but may not be carried back.

3. Value added tax (VAT)

VAT applies to most goods and services, including imported goods and services and is levied at the rate of 16.5% Certain items are zero-rated, including exported goods and the provision of certain services to nonresidents.

C. MUTUAL TAX ISSUES

1. Withholding Taxes

When an Israeli company remits dividend, royalty or interest payments to a U.S. party (or vice versa), these payments are subject to a withholding tax as set forth in the U.S./Israel Income Tax Treaty (the “Treaty”). Under the Treaty, the maximum withholding tax on these payments is 25% for dividends, 15% for royalties and 17.5% for interest payments.

2. Intercompany Transactions

The IRS scrutinizes intercompany or related parties transactions (e.g., transactions between U.S. headquarters and Israeli subsidiary) to ensure that the parties conducted the transaction at arm’s length and that the related parties did not set prices at artificial levels in order to avoid the tax that would have been due had unrelated parties negotiated the price.

The IRS has published guidelines for evaluating whether or not a transaction between related parties was conducted at arm’s length. These guidelines provide a number of methods depending on the type of business and products sold.

The Israeli transfer pricing rules are based on the OECD guidelines. Several pricing methodologies apply, with preference given to transaction-based methods over profit-based methods.

OUR SERVICES
Rimon Law Group is well positioned to assist you and your clients with cross border tax issues, especially between the U.S. and Israel as a result. Our attorneys have extensive experience and expertise in international tax and cross-border transactions. Every attorney in our Israel Practice Group is licensed to practice in both the United States and in Israel, is fluent in both Hebrew and English, and has at least ten years of experience at top U.S. and Israeli law firms and companies.
If you have any questions about international tax issues you can contact Dave Wolf, Esq. at Dave.Wolf@rimonlaw.com. To discuss Rimon’s Israel practice group, you can contact Michael Moradzadeh, Esq. at Michael@rimonlaw.com.

Circular 230 Disclaimer: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or tax-related matter(s) addressed herein.

Oracle’s takeover of Sun Microsystems is facing the European Union’s competition regulator’s investigation, and the prospect of Google’s ambition of building a digital library is still unclear because some publishers and writers reckon the accessibility of large volume of online books will damage their economic interests. While small tech companies and start-ups are worrying about their sources of capital and the outlet of their products, the big tech companies are also undergoing tough scrutiny from both the governments and their competitors.

Oracle’s deal is a typical M&A deal among two tech companies in order to complement each other and expand their market shares, and it is not uncommon to trigger the anti-trust examination. Google’s “monopoly” is sort of untraditional, since the platforms of the competition are not overlapping: one from the physical word, i.e., the physical books, and the other is from the virtual word, i.e., the books on the internet.

I do like Google’s fantastic idea of making millions of books digitally available to the general public, and do admire its ability of making it true. While creation is the life of a tech company; having a good idea and making it good is the key to the success of a tech company, no matter it is only a startup or a giant.

Lots of young entrepreneurs in Silicon Valley these days hope to begin their business, let people know their companies, and furthermore, draw the attention of venture capitalists, who will devote money to their new enterprise.

Something that an entrepreneur must keep in mind is something that he must give up to VCs when getting money from them – most commonly stock of the new company. Generally, a venture capitalist asks for “preferred stock” from the entrepreneurs; the owner of preferred stock enjoys shareholder rights superior to the shareholders of common shares.

Most types of preferred stock are designed to convert into common stock (for example, one share of preferred stock converts into five shares of common stock), either at the discretion of the investors (voluntary conversion) or when some preset threshold is reached (automatic conversion, for example, in a public offering scenario). Thus, the conversion condition, time of conversion (voluntary or involuntary), and the conversion rate, is always one of the most fiercely argued clauses in the investment negotiations between VCs and entrepreneurs.

Of course, another major issue to consider before seeking venture capital is the loss of control of your company. When VCs invest, they want to make sure their investments are secure, so they often require a seat on the board of directors and certain voting rights. This means an entrepreneur effectively has a new boss. This can be a good thing since VCs often add experience and credibility to the company. However, this often causes power struggles between the entrepreneur and the venture capitalists.

INTRODUCTION

As most of you know by now, there may be more than 50,000 U.S. taxpayers who have held accounts at UBS in Switzerland that were undisclosed to the IRS. They could face criminal prosecution and significant penalties.

VOLUNTARY DISCLOSURE PRACTICE

The IRS has had a voluntary disclosure practice in its Criminal Manual for many years.

The IRS has now implemented a special approved penalty framework for resolving the civil side of offshore voluntary disclosures and this approved penalty framework is effective till September 23, 2009 at which time the IRS intends to re-evaluate the approved penalty framework. Under the approved penalty framework, the taxpayer has to file correct or amended tax returns for tax years 2008 back to 2003.

Taxpayers with undisclosed foreign accounts or entities should make a voluntary disclosure because it enables them to become compliant, avoid substantial civil penalties and generally eliminate the risk of criminal prosecution. When a taxpayer truthfully, timely, and completely complies with all provisions of the voluntary disclosure practice, the IRS will not recommend criminal prosecution to the Department of Justice.

Making a voluntary disclosure also provides the opportunity to calculate, with a reasonable degree of certainty, the total cost of resolving all offshore tax issues. Taxpayers who do not submit a voluntary disclosure run the risk of detection by the IRS and the imposition of substantial penalties, including forfeiture of the money in the foreign accounts, the fraud penalty and foreign information return penalties, and an increased risk of criminal prosecution.

REPORT OF FOREIGN BANK AND FINANCIAL ACCOUNTS

The purpose for the voluntary disclosure practice is to provide a way for taxpayers who did not report taxable income in the past to voluntarily come forward and resolve their tax matters. Thus, if a taxpayer reported and paid tax on all taxable income but did not file a Report of Foreign Bank and Financial Accounts (FBAR), the taxpayer should not use the voluntary disclosure process but should file the delinquent FBAR.

An FBAR gets reported by filing Form TD F 90-22.1 with the Department of the Treasury (not the IRS) on or before June 30, of the succeeding year.

An FBAR is required to be filed for all accounts where a U.S. person or entity has a financial interest or signature authority in foreign financial accounts if the aggregate value of these accounts exceeds $10,000 at any time during the calendar year.

In the case of a corporate officer, for securities that are listed on a national exchange over which there is no direct financial interest on the part of the officer, there is not an individual filing requirement. This exception is only if the organization has filed the Form and notified the officer in writing that they are not required to file.

CRIMINAL CHARGES AND CIVIL PENALTIES

A person convicted of tax evasion is subject to a prison term of up to five years and a fine of up to $250,000. Filing a false return subjects a person to a prison term of up to three years and a fine of up to $250,000. A person who fails to file a tax return is subject to a prison term of up to one year and a fine of up to $100,000.

Failing to file an FBAR subjects a person to a prison term of up to ten years and criminal penalties of up to $500,000.

OUR SERVICES

Rimon Law Group is well positioned to assist you and your clients with foreign
disclosure matters as a result of our attorneys’ extensive experience working with high-net-worth individuals and companies and their expertise in international tax.

We have made extra efforts for the next three weeks for our attorneys to be available to speak with you in more detail about how we might work with you to ensure that you or your clients take the smartest steps and make the best decisions when it comes to foreign bank account disclosure and the IRS voluntary compliance program.

FOR FURTHER INFORMATION
Additional information about the foreign bank account disclosure or the IRS voluntary disclosure practice can be found on the IRS website or by contacting Dave Wolf, Esq. at dave@rimonlaw.com

Circular 230 Disclaimer: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or tax-related matter(s) addressed herein.