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Your Taxes: Seven Things To Consider When Structuring Your Business

Starting a business is no picnic, so you should always write a business plan. This will include basic things like goals, competitive advantage, marketing, operations, finance, legal protection, risk management and timing. Not to mention tax planning. Here’s a few more macro level tips to consider.

1.  Self employed or company?

Going self employed is cheapest but there is less legal protection in the event of a lawsuit. Israeli tax and national insurance rates for self employed can range up to 50% of the profit, as soon as you make it.

A company generally offers a degree of legal protection in the event of a lawsuit. This matters in certain sectors such as food. However, banks usually want a personal guarantee from major shareholders and the Israeli Tax Authority has priority over shareholders and other creditors.

Israeli companies generally pay company tax at a rate of 25% on profits and their major shareholders will top that up to 47.5%-50% if and when they take a bonus or a dividend.

An Israeli company can be advantageous if Israeli operations make more profit than you need to live on – you can leave the profit in the company for the time being after paying the 25% company tax. The company can invest the rest. The tax top-up to 47.5%-50% may be deferred until you need a bonus or dividend – which can be years later sometimes.

2. Shares/Options vs. Loans/raising capital

Share capital is advantageous because it doesn’t usually have to be repaid. But repayment of shares has to be out of profits or replacement shares issued. By contrast loans can be repaid out of any available cash. Shareholders’ loans can bear interest or be interest free. Any such interest is taxed at marginal Israeli rates ranging up to 50%. Indexation (inflation adjustment), only, on a loan may be tax free for the shareholders, but a deductible expense for the company, if certain conditions are met

3. Offshore company vs, Israeli Preferred Enterprise

Offshore companies are targeted by anti avoidance rules, but may still work sometimes if the transfer pricing, value generation and risk management are checked out fully.

But Israel offers tax breaks. Israeli companies with a “preferred enterprise” in industry and technology may pay company tax as low as 9% in development area A and 16% elsewhere, if they are in biotech or nanotech or their exports amount to 25% of sales.  The withholding tax on their dividends is 20%. The resulting combined tax burden on distributed tax break profits is therefore 27.2% – 32.8%.

4. Where should the IP be?

Intellectual property (IP) usually refers to knowhow or a trade name or a brand.

The IP should be in the country with real people who create real value after assessing and mitigating risks. The taxes can also be low, but get the above right first, or else the structure will be challenged.

5. Cost Plus vs. Hourly or Monthly Fees

A cost plus basis means a company providing R&D or support services has all its costs repaid plus a profit uplift. The ITA has indicated in a ruling that cost plus 10% may on occasion be considered to be the going market rate. But not if the service company owns IP or runs risks.

Hourly rates or monthly subscriptions may result in a higher or lower profit than a cost plus basis.

A cost plus is always positive, losses are not possible even if the group as a whole is making losses.

6. Employees vs. Subcontractors

People who work full time for one party are likely to be treated as de facto employees, for legal and tax purposes. De facto employees may sometimes trigger sudden liabilities – severance pay, work accident compensation, etc. Legal advice is needed as well as consideration of tax aspects.

7. Going international/spreading your wings.

Playing to a global market means more potential profit, but it isn’t plain sailing. Initially, doing business yourself WITH customers in another country may not trigger local income tax liability. But having a local agent or office IN that country may trigger a taxable “permanent establishment” which means tax in more than one country. Check how to comply or legitimately avoid this. Check how to credit foreign tax.

The internet and recent OECD pronouncements have heightened such exposure. As for VAT/sales tax, even bigger amounts may be involved and harder to avoid in locations like the EU and US, especially for ecommerce/digital service supplies. Upfront checking is necessary.

As international business expands, it is common to set up local subsidiary corporations – if so check the transfer pricing of intragroup transactions meets “arm’s length criteria” – a transfer pricing study is usually required. Strangely, this may be less of a chore, more of an opportunity for tax planning…

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

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The writer is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd