The Israeli Supreme Court has just shot down the use of a company incorporated in Ramallah (Shai Tzmarot (Oranit) Vs VAT Director Petach Tikva, Civil Appeal 1609/16, handed down November 1, 2018). This was done using the old UK tax concept of central management and control, but with a Hebrew twist…..
This was a VAT case, but the result is probably equally valid for income tax purposes.
The company in question was incorporated in Ramallah in 1985. It came to be used to develop land in Oranit which is over the green line, pursuant to a creditors arrangement administered by trustees at a law firm based in Jerusalem. The Ramallah company came under the ownership of a Panamanian company (99%) and 1% by the shareholder of the Panamanian company who was a resident and citizen of the US.
A key issue was whether the deal was subject to land appreciation tax or VAT or neither. Israeli tax law applies to Israeli citizens in the administered territories, but does it apply to a Ramallah company owned essentially by a US resident and citizen?
The Supreme Court ruled that based on their reading of the law, regular Israeli tax law applies to Israeli residents on their worldwide income. That includes Israeli resident companies. A resident company includes a foreign company whose business is controlled and managed from Israel. In this case, the Court ruled that the trustees in Israel effectively controlled and managed the business of the company.
But was that enough? The taxpayer claimed that “control and management consists of two separate tests: (1) control, and (2) management. The Israeli tax authority (ITA) has long claimed that “control and management” is one general test which looks at effective management.
The Supreme Court said it isn’t deciding this issue, then goes on to side with the ITA. The Court ruled that control and management has to be “exercised”.
This apparently means reviewing who exercises control and management in practice, not who can exercise control and management by force (e.g. the American shareholder).
The Court ruled that Israeli trustees exercised management and control of the Ramallah company in practice in Israel, making it resident and taxable in Israel.
The words “exercise” and “in practice” are from the same route in Hebrew (mufal, befo’al) which seems to explain the Court’s ruling that it is necessary to review who exercises control and management in practice. This is very similar to UK cases that ruled it is necessary to review who calls the shots!
Was this a political case? Perhaps, but the politics were side-stepped and the result is quite diplomatic. Israeli residents were involved and they have to pay tax on worldwide income. Using a Ramallah company didn’t reduce the Israeli tax exposure.
As always, consult experienced tax advisors in each country at an early stage in specific cases.