OECD reports on Israel Tax Authority functioning: Why does it matter?

This is highly relevant to international business and investment, as well as immigrants.

The OECD attaches great importance to the smooth functioning of mutual consultation between tax authorities of different countries, to help iron out double taxation issues.

• One example is an Israeli R&D operation compensated by a multinational group on a cost-plus basis (e.g., total costs plus 10%). Recently the ITA has begun questioning whether cost-plus compensation should be replaced by a global profit split based on the Israeli operation’s deemed contribution to global profits. If a foreign tax authority refuses to accept the ITA’s profit split or allow a foreign tax credit, double tax may ensue.

• A second common example concerns immigrants who are exempt from Israeli tax for 10 years on income from work done abroad. The ITA claims the flight days are days worked entirely in Israel. Suppose an immigrant takes off from Ben-Gurion Airport at 6 a.m. and flies to London arriving at 9 a.m. London time. Israel will tax that day’s income. So may the UK, resulting in potential double tax each flight day.

• A third common example concerns immigrants who sell shares or options from a foreign multinational. The ITA currently denies the 10-year exemption to an immigrant who qualifies for a 25% tax rate for employee share/option plans under Section 102 of the Income Tax Ordinance. Expatriates in Israel and US immigrants may not get a foreign tax credit for Israeli tax apparently not due.

What does the OECD model tax treaty say?

Article 25 of the OECD model tax treaty says that where a person considers that the actions of a tax authority will result in double taxation, he may present his case to the competent tax authority of either country within three years from the first notification of the action. If the objection appears justified and if it is not itself able to arrive at a satisfactory solution, that authority shall endeavor to resolve the case by mutual agreement with the competent tax authority of the other country notwithstanding any time limits in domestic laws.

The OECD says that a few Israeli tax treaties do not contain clauses echoing the OECD MAP provisions. Also, Israel may not provide access to MAP while a court case is pending.

In general, the OECD has set a 24-month deadline for concluding MAP negotiations, but in 2016-2018 the ITA took on average 37 months for MAP cases regarding income allocation between countries. But the ITA was quicker with other cases at 28 months on average.

Also, Israeli tax circular 23/2001 sets forth the Israeli MAP procedure, but in Hebrew only. To prove the point, the OECD refers to the tax circular as an order, which it isn’t. And taxpayers are advised to apply to the International Division of the ITA without saying where it is located. In our experience, even local tax officials are not always sure how to apply to the ITA’s International Division.

The MAP procedure is clearly bureaucratic. As the OECD tries to press on with international tax reform for multinationals, it faces criticism from the US Treasury and practitioners (such as us) about lack of simplicity and lack of fairness in the latest OECD proposals, known as Pillar 1 (minimum tax in consumer countries) and Pillar 2 (minimum tax globally and in the home country).

Also, there is no requirement in Israel’s tax treaties for the ITA to reach agreement with any other country’s tax authority. They could keep talking forever.

What is needed in our view is a King Solomon, or in this context, an international tax tribunal system to reach a clear decision within a reasonable time-frame, including a right of appeal. Some may argue this means surrendering tax sovereignty to such a tribunal. On the other hand, international arbitration is already an accepted way of resolving business disputes, why not double taxation disputes?

As always, consult experienced tax advisers in each country at an early stage in specific cases.