INTRODUCTION
Transfer pricing is increasingly influencing significant changes in tax legislation around the world. This 18th issue of BDO’s Transfer Pricing Newsletter focuses on recent developments in the field of transfer pricing in Australia, Israel, the Netherlands, and India. Transfer pricing is becoming increasingly important for both tax authorities and tax payers around the world, with various countries introducing new legislation and guidance with respect to transfer pricing. As you will read, various countries are also showing initiatives following the finalization of OECD’s BEPS project, which are expected to expand over the coming months.
We are very pleased to bring you this issue of BDO’s Transfer Pricing News, which we were able to produce in close co-operation with our colleagues from the above-mentioned countries. We trust that you will find it useful and informative. If you would like more information on any of the items featured, or would like to discuss their implications for your business, please contact the person named under the item(s). The material discussed in this newsletter is intended to provide general information only, and should not be acted upon without first obtaining professional advice tailored to your particular needs.
ISRAEL
NEW TRANSFER PRICING DECREE
In the context of increased economic activity through the medium of the internet (“the digital economy”), and following the BEPS action point 1 discussions on the tax challenges of the digital economy, and action point 7, which discusses the prevention of artificial avoidance of permanent establishments (“PEs”), the Israeli Tax Authorities have issued a draft circular expressing their intention to extend the current interpretation of the PE rules to include profits derived from the digital economy. The aim is to increase the ability of the Israeli Tax Authorities to collect tax from foreign entities that have established a PE in Israel via the provision of services. This draft circular does not refer to foreign entities that sell products in Israel.
Taxation of a foreign entity
The income of a foreign entity which will be liable to tax in Israel is as follows:
- If the other country in which the foreign entity is resident has not signed a Double Tax Treaty with Israel – the income of the business activity (or some of it) which is performed in Israel.
- If the other country has signed a Double Tax Treaty with Israel – income only taxable if the business activity establishes a PE in Israel.
Establishment of a PE
A foreign entity that provides services in Israel will be regarded as establishing a PE in Israel only when it has a fixed place of business or when it performs its activity via a “dependent agent”.
Fixed place of business
According to the interpretation of the OECD’s model Double Tax Treaty, a fixed place of business that may establish a PE is considered to be, inter alia, where a business has placed a physical internet server.
However, according to the Israel Tax Authority’s current interpretation, in the context of a digital economy, a fixed place of business that establishes a PE might be deemed to exist also where a foreign entity performs its core economic activity.
Foreign entities which operate through physical facilities in Israel that provide the foreign entities with a business activity other than an auxiliary activity might establish a PE in Israel. Additional examples of when a PE might be established are as follows:
- The entity owns a physical facility (as well as a website) which operates a site specifically aimed at Israeli users e.g. in terms of language, currency, focused adverts and style.
- The website links Israeli customers with Israeli service providers.
- The volume of traffic on the site reflects high popularity with Israeli users.
- Representatives of the foreign entity in Israel are involved in identifying customers, or gathering clients or information in order to help stimulate Israeli-based business with the help of a physical facility in Israel.
- Significant marketing and support services are provided in Israel via the foreign entity’s representative.
- Added business risks are created from the business exposure in Israel.
- A significant number of agreements to provide digital services are signed between the foreign entity and residents from the same country via the internet alone (“significant digital presence”).
- The foreign entity’s services are consumed in the same country to a large extent (“significant digital presence”).
- The foreign entity receives significant payments from residents, related to contractual obligations for the provision of services that are part of the entity’s core activity (“significant digital presence”).
- APE can be created, inter alia, when an employee contractually works for an Israeli company, yet acts according to the foreign entity’s orders.
- The foreign entity is involved in the recruitment of an Israeli employee even though he is due to be employed by a separate Israeli company.
A dependent agent
Under the OECD guidelines, a PE will also be established in Israel by a dependent agent who has authority to conclude contracts on behalf of the foreign entity on a regular basis. A dependent agent who only initiates negotiations with potential clients on the basis that this might eventually bind the foreign entity, might also establish a PE for the foreign entity.
Some examples of when an agent conducts contracts in the name of a foreign entity, and therefore might establish a PE in Israel, are as follows:
- An agent has authority to fix a price or other commercially binding terms.
- Circumstances of the contract are dictated to the agent and he has judgment regarding the circumstances.
- The agent is involved in adapting the contract to the client’s needs.
- The agent is a party to the contract.
Allocation of profits to PE
After it has been determined that a PE has been established in Israel, the profits of the Israeli-based operations must be appropriately distinguished from those of the worldwide business, and this amount will be subject to Israeli tax. The distinction would be determined according to the instructions of the 2010 OECD report on the attribution of profits to PEs.
Submitting separate reports
When it is determined that the activity of a foreign entity is performed through a PE, two separate reports should be submitted: one regarding the foreign entity’s income that was derived through the PE, and the second regarding formal activity if performed by the foreign entity via an Israeli entity in Israel.
Should the foreign entity that provides services in Israel be obliged to register in Israel for VAT purposes?
The main rule derived from the VAT law in the context of a foreign entity that provides services in Israel is that a foreign entity that has activity in Israel, to the extent that it would be seen as a business, will be liable to VAT for its business activity, and would be required to register in Israel as a licensed business.
When there is a direct link between the services that the foreign entity provides to Israeli clients via the internet (that are significant) and Israel, then it is possible to determine that under those circumstances, the foreign entity performs a business activity in Israel.
Examples of when a foreign entity might be obliged to register as a licensed business in Israel are as follows:
- A foreign entity operates a search engine providing publication services to Israeli clients that are directed to Israeli users or consumers.
- A foreign entity operates an internet website for booking rooms in Israeli hotels for Israeli clients.
In conclusion
Needless to say, the Israeli Tax Authorities (Israel being a member of the OECD) are putting much effort into collecting tax derived from activities of the digital economy.
Your BDO contacts in Israel:
AMIT SHALIT
amits@bdo.co.il