Permanent Establishment in Israel
In recent rulings and circulars, the Israeli Tax Authority ("ITA") expanded the doctrine of Permanent Establishment in Israel. This tendency is explained by the motivation of the ITA not only that foreign companies operating in Israel will be subject to taxation in Israel for income attributed to the Permanent Establishment but also that New Residents under the Ten Year Tax Holiday will be taxable in Israel for income paid to them from such Permanent Establishment, as it does not constitute a foreign source income.
One of the examples for the expansion of the Permanent Establishment doctrine was made in a controversial ruling issued (in agreement with the assesse) in 2012 entitled: "Permanent Establishment in Israel for a foreign company that engages an individual working from Israel- a tax ruling in consent" (the: "Ruling").
The facts of the Ruling, in brief, were as follows: a foreign company which provided financial services to clients situated outside of Israel (the: "Foreign Company") and did not market its services in Israel, entered into an employment agreement with an individual residing in Israel, under which the employee was employed as a portfolio manager (the: "Employee"). The Employee was to be employed from her home and was not to engage in marketing or selling or to negotiate on behalf of the Foreign Company with any third parties or to solicit new clients or even meet with clients in Israel.
The ITA ruled that the employment of the Employee in Israel constituted a Permanent Establishment for the Foreign Company in Israel in accordance with the Avoidance of Double Tax Treaty between Israel and the United States.
The Ruling was given on consent and as such the ITA did not provide any reasoning for the conclusion it reached. Therefore, it is unclear whether the ITA ruled that the Permanent Establishment was established because the Employee was deemed a "dependent agent" (although the Employee had no authority to sign contracts on behalf of the Foreign Company), or whether the Employee's act in Israel established an office or a branch for the Foreign Company (although she was working from her home and did not have any connection to the clients of the Foreign Company).
The Ruling was very controversial and resulted in many articles by tax law experts in Israel who argued that it contradicted previous rulings of the ITA, and the opinion of the OECD as provided in the Interpretation and Application of Article 5 (Permanent Establishment) of the OECD Model Tax Convention.
The Ruling was not withdrawn, but there were no subsequent rulings that went in the same direction or expanded the Permanent Establishment doctrine in the same manner. The Ruling indicates that it would be very hard to predict the approach of the ITA in any specific case as the ITA did not adopt any specific discipline or interpretation to the Permanent Establishment doctrine.
Nevertheless, subject to the examination of the specific case at hand and the facts and circumstances applicable to it, we are of the opinion that the Ruling should not apply in cases where the foreign company engaged a service provider which is financially and economically independent from the foreign company and is expected to, and de facto does take decisions, and provides consulting services based upon its business discretion. Such service provider should not have authority to bind the foreign company on agreements and in no event should he engage in any form of solicitation of clients including any advertising or any act of marketing in connection with the foreign company or have direct contact with clients of the foreign company.
This article was contributed by Rosak
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