Jerusalem 1997 meeting

Ancient hebrew laws provide for taxes of various kinds and deal with tax avoidance and foreign tax credit. Investors in Israel need to take into account their contemporary equivalents.
A joint venture by non-resident investors and an Israeli company raises a number of tax issues. Repayment of a non-resident’s loan is plainly capital and has no tax consequence, but the interest element carries 25% withholding tax, unless a treaty provides otherwise. “Interest” is not defined for domestic tax purposes, but an appropriate part of the investors’ reward may be characterised as business profits, and this will be advantageous where a treaty is applicable (and in the UK treaty, exemption for business profits is not – unlike that on interest – dependent on remittance).

Exchange control approval for profit repatriation is helpful in satisfying the Revenue authorities to characterise the outgoing as a business profit.

Company law is based on the English 1929 Act, but a more modern enactment is expected shortly. There are various tax incentives for investment in Israel, and there are no restrictions on foreign shareholdings and directorships. But a jointly-owned foreign company may be the most appropriate vehicle for a joint venture. Transfer pricing rules and the general anti-avoidance provision need to be taken into account, and the foreign company should not be managed and controlled in Israel. The Israeli investor will reap the greatest tax advantage if his profit from the venture can take the form of a royalty.

A route for the interest may be Israel-Netherlands-Netherlands Antilles. This route may also be used for dividends declared by an Israeli company.

Capital gains from Israeli assets (held directly or indirectly) are taxable in the hands of residents and non-residents, but this rule does not apply to securities quoted on the Tel Aviv Stock Exchange, provided the gains cannot be characterised as trading income. The rule does apply., however, to resident Israeli companies.

A testator in a civil law country may wish to leave his estate in some fashion not provided by civil law. In Anglo-saxon countries, movable property generally passes in accordance with the deceased’s domicile and immovable by the law of the situs. Civil law countries apply the law of the deceased’s nationality or “domicile” (in the sense of habitual residence). The effect of renvoi also needs to be taken into account, where it is applied (e.g. in the case of an Englishman dying domiciled in Spain, a Spanish court would look to English law (the national law) but English law sends the matter back to Spain). The Hague Succession Convention may in due course help to simplify the complex consequences of these rules.
Subject to conditions, which differ from one country to another, a beneficiary may “claw back” gifts which result in his expected share being eroded. In Switzerland, 3/8 is freely disposable where the deceased leaves a surviving spouse and children; in France up to _ is freely disposable, depending on the number of children, but a wife is not a reserved heir; in Italy the spouse is entitled to and is freely disposable.

In Switzerland, one claws back gifts made within 5 years and any gift made with intent to defeat the legal reserve.

An intending testator in a civil law country may emigrate to another country where forced heirship does not apply, or change his nationality or invest in real estate in a common law country. An intending common law testator with real property in a civil law country may put his property into a company (though this manoeuvre recently failed in France); he may (in some countries) have a right to elect to have his national law govern his estate. The heirs in certain countries (e.g. Switzerland and Germany) can agree to vary the manner in which the law would distribute the estate but in France such “inheritance pacts” are invalid. However, in France a “tontine” agreement falls outside the forced heirship rules.

If the deceased with a civil law domicile has validly created a trust in eg England, will the Court afford a remedy to an aggrieved heir? In order to avoid this difficult question, the Cayman Islands enacted its law of 1984 (amended 1995). Some 20 offshore jurisdictions have followed suit – including Cyprus and Mauritius, where laws contain forced heirship provisions. An aggrieved heir may plead lack of capacity of the settlor to make a trust, claim that the transfer is invalid, invoke the doctrine of “fraud on the law”, bring an action for reduction or seek damages for conspiracy (against the beneficiaries, the trustees or even the adviser). In the trust jurisdiction, a successful claimant in a foreign jurisdiction could seek to enforce a foreign judgement.

The establishment of the trust, to be effective, should be carefully considered – in particular, the trust property should not be sited in the forced heirship jurisdiction. A provision may be made for a beneficiary who challenges the trust to be excluded. The beneficiaries’ right to information may be limited: in the Lemos case, the Cayman court disapproved of such a provision in general terms. The Bahamas has a Bill which, if enacted, will provide for trustees to deny information to beneficiaries.

In Israel, Islamic law is applied to some degree to Muslim citizens in Islamic courts. Egypt, by contrast, abolished its Islamic courts in 1956. Islamic law is applied in different ways in different countries: Kuwait has a recent code, and Saudi Arabia relies on oral tradition and early writers: each country has its own rules and laws on succession.
The core Islamic rules of succession, however, are essentially similar in all Muslim countries. A Muslim does not have testamentary freedom: at least 2/3 of his estate must pass in accordance with the rules. The Sunni and Shia rules have some differences (the Shia Muslim may bequeath property to an heir, a Sunni Muslim may not), but the Sunni Hanafi rules apply to a majority of Muslims – including those in Israel. There are three categories of heirs:

1. The Quranic Heirs

Daughters are the main beneficiaries. The wife (or husband) takes a share, as do children, parents and siblings, but no share is given to a son or full brother. Minor children (generally under 15) require a guardian, normally male.

2. The Agnatic or Residuary Heirs

They would have taken under pre-Islamic law: i.e. the sons. The existence of a son converts a daughter from a Quranic heir to a residuary heir and thereby reduces her status considerably, particularly because the son will take twice the share of the daughter in these circumstances. The calculations can become quite complicated.

3. The Outer Family

They take where the deceased leaves no children. The rules are detailed and their application and interpretation is not free from difficulty and variation.

The fixed shares in an estate do not necessarily add up to one. There are rules of apportionment to deal with this case. Islamic law does not provide for orphaned grandchildren; this rule has been modified in some countries – sometimes by way of a notional bequest under a will.

A will may be valid as regards 1/3 of the estate, and it cannot contain a bequest to a person who inherits under the law – though this rule has been modified in some countries where the Shia view is applied.

Children conceived outside marriage do not take from their father. Nor do non-Muslims – children taking the religion of their father. Foreign law is generally not applied.

Islamic law is generous to women, but its disadvantage is that it leads to fragmentation of an estate. Islamic law recognises liberty to make gifts – not being a gift “in death sickness”, which will be treated as a bequest. Changes in inheritance can also be affected by marriage and divorce.

The waqf antedates the English trust. It is constituted by a gift in perpetuity. They provide for good causes – building of mosques, schools etc – but the maintenance of a family is also treated as a good cause. These were popular in the 18th and 19th centuries until much property had become subject to the “dead hand” of the waqf. There have been some reforms – permitting waqf property to be sold or limiting the duration of a waqf.

Muslims are generally happy with the provision of Islamic law but sometimes – e.g. where the Muslim has a non-Muslim wife – a modification is necessary.

Property investment in the United Kingdom prima facie involves tax on rent, but this is after deduction of interest. As rent from a property rises, it may be appropriate to refinance, so as to increase the interest payable. Tax needs to be deducted on interest arising under Case III of schedule D: in determining this, the relevant factors are four: (i) the borrower’s residence, (ii) the source from which interest is paid, (iii) the nature and location of the security for the borrowing, and (iv) is the interest payable in the UK? A back-to-back loan structure effected wholly outside the UK is tax-efficient, and a Jersey bank has the merit that it may claim that the interest it receives is part of its business profits. It is considered that s787 is not in point: a Parliamentary statement to this effect was made when this measure was introduced.
A non-UK company is the preferred investor; it may nevertheless register for VAT. The amount borrowed should be “reasonable” – e.g. around 75%. The bank’s turn if a back-to-back is used is negotiable: 1% is generally asked for. The company is incorporated abroad: its shares are thus not UK assets for inheritance tax. The company is also resident abroad and therefore not subject to tax on its capital gains. A trading profit, on the other hand, is taxable, though the buyer is not required to withhold any tax, but section 776 needs to be kept in mind. For trading, a treaty country should be used – e.g. Jersey (where the tax rate can be reduced to an agreed 6%). The Jersey company may be owned by a Netherlands holding company, in turn owned by an Israeli company, to allow monies to flow efficiently to Israel utilising the UK-Netherlands treaty.

Licensing patents into the United States involves in principle a 30% withholding tax. Interposing a conduit e.g. in the Netherlands can cause the US to invoke the “cascade royalty” concept. The taxpayers succeeded in a case last October – SDI Netherlands, where the intermediary had a real profit-earning function. This case may now be decided differently following subsequent changes to the US-Netherlands treaty (the limitation of benefits provisions).

Alternatively, a UK resident company may buy, say, a 10-year patent right from an offshore company with back-to-back finance. The taxable profit of the UK company will be reduced by 25% writing-down allowances (depreciation) so that very little UK tax will be paid. An Austrian company may be used in a similar way.

Much commercial and criminal law is based on British models; the legal profession is fused. Exchange control is administered by the Central Bank; it is being phased out and forecast to be abolished in the foreseeable future; the rules have been recently relaxed relating to non-resident loans, acquisition of foreign shares, remittance of profits by foreign companies, inheritance, emigration, travel allowances, forward transactions and futures, foreign listings, Israeli companies investing abroad and foreign company share offerings in Israel.
New immigrants have a 30-year exchange control holiday. Returning former residents may have a 10-year holiday. Non-resident investors have statutorily guaranteed repatriation rights; trust companies may, on application to the Bank of Israel, maintain non-resident accounts for non-resident beneficiaries.

The Law of Return was enacted in 1950. The expression “Jew” is defined in the Law, but has been the subject of controversy and court decisions. Israeli citizenship and nationality is readily acquired and renounced. New immigrants should conclude any restructuring of their personal affairs before immigration.

From 1992, the Bank of Israel gave a number of non-resident certificates to companies carrying on business abroad. This policy was changed in 1995. However, since April 1995 an active Israeli company has been able to capitalise a non-resident subsidiary.

A trust has the legal capacity to inherit; the income of a foreign trust may remain free of tax even if remitted to Israel; the trust may be used to hold Israeli residential property so as to retain the exemption from tax on capital gains to which individuals are entitled.

Israeli law recognises testamentary freedom but (unless the parties contract otherwise) provides community of property.

Planning for investment in South Africa requires, first, an overall view of the South African tax system. There are some restrictions on local borrowing and a number of specific incentives. South Africa’s tax system is essentially territorial, but the deeming provisions may be broadened to include income arising abroad to local and foreign residents. Corporation tax is at 35%, plus a 12.5% Secondary Tax on Companies (STC) applying to net dividends declared in later accounting periods.
Restrictions on local borrowing may be circumvented by borrowing by a trading trust where the sole beneficiary is a South African company owned partially by non-residents. There are transfer pricing and thin capitalisation rules, but few other anti-avoidance provisions. Enterprises satisfying certain conditions can have tax holidays or accelerated depreciation.

Exchange control is unlikely to be abolished totally in the short term but is being phased out. For the inward investor there is no need to obtain consents, but for outward investments, exchange control consent will be granted for investments calculated to reduce imports, increase exports or create jobs.

Foreign companies can operate through a branch. A branch pays an extra 5%, but a branch can be converted to a company without tax cost.

There is no withholding tax on dividends or interest; royalties suffer 12%, but treaties (eg with the Netherlands or Hungary) may be used.

There is no capital gains tax. To avoid STC on liquidation, the local company may first sell its business to its parent and then go into liquidation.

There have been for some time treaties with the Netherlands, Israel, Switzerland and the United Kingdom. There are several new treaties and others on the way. Treaties with other African states encourage the use of South Africa as a base for investment elsewhere in Africa.

Financial and offshore centres feed off each other: offshore centres have traditionally grown up near the financial centres. Modern communications and economic changes nowadays enable offshore centres to emerge and grow in more distant places – e.g. in the Gulf region. The region is mostly Arab. The Shia law provides for a kind of trust (the waqf) but ownership of companies is generally restricted to local citizens.
In 1975, Bahrain launched a programme to diversify away from dependence on oil; it has succeeded Beirut as an offshore banking centre and has instituted free zone areas. There are no taxes, except those relating to oil. Since 1977, “exempt companies” have been available: they may be owned by foreigners; they are essentially offshore vehicles. But the rules were over-strict; they were somewhat relaxed in 1992, but doubts over its political stability seem to have prevented Bahrain from developing further than as a centre for accessing the market in Saudi Arabia.

Dubai is the dominant member of the United Arab Emirates. It has established the Jebel Ali Free Zone. As a distribution centre, the Zone has been a huge success. Since 1985, foreigners have been able to own companies in the Zone. In 1992, the “FZE” was introduced: it is a one-man company with a simple incorporation procedure. It can carry on business in the Zone and abroad.

The Seychelles were the first offshore centre in the Indian Ocean. Its first attempt, in 1979, was not a success, but a new initiative in 1994 brought a whole new set of offshore legislation and saw the establishment of SIBA, a government “one-stop shop” for the offshore user.

Mauritius also has offshore legislation, but here the emphasis is on the treaties to which the country is party. There are treaties with China and Pakistan, but the most important one is the treaty with India. An Indian adverse ruling in the NatWest case has been succeeded by a favourable ruling for a collective investment scheme. There is no doubt that the India treaty will stay, but it is likely to become of less importance as India liberalises its tax rules.

The offshore tax regime in Mauritius is based on an ostensible 15% rate, which is effectively reduced to 3% by credit for foreign taxes, real and notional. With its treaties with the major countries on the Indian Ocean rim, the offshore centre in Mauritius seems to have a secure future, but much depends on the economic future of South Africa.

Twenty-three treaties are in force, and several more are in preparation. Like all other tax treaties, the Israeli treaty seeks to divide the tax take between it and the treaty party. The banks give effect to withholding tax rules but will only apply treaty exemptions and reduced rates if it receives a tax confirmation issued by the tax official. Otherwise, the banks will withhold tax at a rate of 25% on income remittances abroad. Treaties vary one from the other – e.g. in the length of time a construction site is tax-free, in the prerequisites for relief from tax on capital gains or personal services, in provisions for credit or exemption.
Generally, the expression “Israel” is defined as “the state of Israel”. This does not include the jurisdiction of the Palestinian Authority e.g. in Gaza or Ramallah. Under an “approved enterprise” regime, Companies benefit from certain incentives and have lower tax rates on profits and on dividends also. Credit for foreign taxes may extend to credit for underlying tax – e.g. in the treaties with the UK, the US and Singapore. The US-Israel treaty offers foreign lenders the opportunity of applying the regular corporate tax rate on their net interest, instead of a lower rate on the gross.

“Royalties” is defined variously. The tax authorities have been inclined to treat all software payments as royalties, but in certain cases they may treat “shrinkwrap royalties” as a purchase consideration. The US now has detailed regulations to deal with this problem, however formal guidelines have not yet been issued by the Israeli tax authorities. In a small country much turns on negotiation between officials of the tax authority and the advisers of the taxpayer.

The UK treaty, but not that with the US, provides for tax sparing. Using companies to own real estate, and enjoy a treaty capital gain exemption, is a tax opportunity which is increasingly limited.

The Netherlands holding company is much used for inward and outward investment. Israel has no anti-treaty-shopping rules as such, but treaty shopping can be caught by the general anti-avoidance section of the tax ordinance, and limitation of benefit provisions appear in post-1991 treaties.

Israel has a “control and management” test of residence. Israeli tax will still be charged on income having its source in Israel. This is defined as income accrued, derived or received in Israel.

There is no routine exchange of information under treaties, but specific requests for information may be made.

Israel has no branch profits tax on regular business profits. A 15% branch tax applies on profits derived by an approved enterprisee. A foreign company doing business in Israel must register – which alerts the tax department. Employees of a branch of a foreign company are taxed, but a special regime applies to expatriates working temporarily in Israel. VAT at a rate of 17% must also be taken into account.

A liaison office not making contracts with customers and not providing services may be exempt under a treaty or be liable to tax only on a cost-plus basis.