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September 21, 2021

Israeli Tax Authority finalizes international tax reform package for further discussion and potential legislation

Following comments from various working groups, the Israeli Tax Authority (ITA) finalized its proposals for international tax reform that will now be transferred for further discussion and potential legislation. These proposals are not expected to be included as part of the 2021/2022 anticipated budget, and there is no clarity on the timeline for the legislation of the proposals made within this package. That said, with the finalization of the package, companies are considering the potential impacts and, in some cases, implementing required adjustments.

The topics that are currently covered under this package, among others, include the following:

Foreign Tax Credit (FTC) rules

The current intention is to: (i) reduce the number of baskets of income; (ii) allow the use of FTCs only if they were paid in countries with which Israel can exchange information and exclude FTCs that were paid in so-called black and gray listed countries, unless a pre-approval was obtained from the ITA; (iii) eliminate the ability to carryforward FTCs, with certain exceptions; and (iv) expand the level of tiers (from two to four) from which dividend distributions can enjoy indirect tax credit in Israel, subject to certain conditions and holding rates.

In light of the potential expansion of indirect tax credit to four tiers, companies should review their structure and consider adjustments that may be required in order to utilize the potential benefit, once legislated. Consideration should also be given to the timing of certain events, and whether those should be accelerated or delayed, where companies are advised to look into the make-up of their FTCs and follow additional developments and potential upcoming grandfathering rules, in order to make such decisions and efficiently plan FTC utilization. Planning should also take into account suggested changes to the controlled foreign corporation (CFC) rules, as detailed below.

CFC rules

These include, among others, expansion of the definition of “passive income” to certain types of royalties and interest, as well as to insurance income, income from financial assets, and capital gain from the sale of intangibles held for more than one year, that were generated from transactions with related parties.

It is noted that while the current proposal allows for the sale of intangibles to be approved by the ITA as income that should not be captured by the CFC rules, it is implied that the adjustment will only be made when the CFC’s profit (rather than its income) is determined, which may result with the company being classified as a CFC due to such capital gain, and even though eventually this gain will not be picked up, other passive income will be.

Another significant amendment is proposed to the passive-active ratio, where it is recommended that the current requirement that more than 50% of the company’s income or profit must be passive in order for the company to be regarded as a CFC for Israeli tax purposes,will be lowered to 30%.

Far-reaching changes are also proposed for the general CFC rules for black and gray listed countries (with exceptions for treaty countries), and for countries with which Israel does not have an exchange of information mechanism, for which the minimal Israeli holding percentage is recommended to be reduced to 30% (instead of the current 50%), and any passive income would be captured (instead the current rule that requires that more than 50% of the income or profit be passive).

These rules are expected to have a significant impact on companies under Israeli control and may result with companies being classified as CFCs for the first time for Israeli tax purposes. Due to the above proposed changes, companies should consider reorganizing intangibles and royalty structures, as well as debt arrangements below Israeli ownership to avoid creating Israeli CFC classifications and inclusions.

Anti-hybrid rules

Following the review of BEPS2 Action 2, the package recommends introducing anti-hybrid rules according to the following principles:

  • The suggested rules will apply on aggregate transfers higher than NIS500k per year.
  • The anti-hybrid situations that are proposed to be introduced are generally consistent with those covered by BEPS Action 2, after several rounds of discussions following which the stricter arrangement suggested by the ITA to be included, were removed.
  • Also, following those discussions, the ITA generally agreed that certain “unintended” situations (such as certain deductions of an Israeli disregarded entity) will explicitly be excluded from the rules.
  • In addition, certain broader rules that were considered to be introduced, such as an equivalent rule to the Pillar Two undertaxed rule, recast of Internal Revenue Code Section 338(g) election as a sale of the Israeli target’s assets, and a rule to deny Israeli domestic tax benefits (capital gain tax exemptions, etc.) to reverse hybrid entities in certain situations – were currently removed from the package. We are specifically monitoring these previously suggested elements.
  • The package currently includes a rule to deny a deduction for payments made to the European Union (EU) list of non-cooperative jurisdictions, and to countries with which Israel does not have an exchange of information mechanism.

Exit tax

This proposal includes significant series of adjustments to Section 100A of the Income Tax Ordinance (ITO), both for individuals and companies. This includes, among others, the update of the current exit tax mechanism to three alternative routes – the immediate tax route, the deferral tax route, and the mixed route that will be applicable where the value of the assets at the time of migration from Israel is higher than NIS3m. The proposal expands the reporting requirements and recommends applying a guarantee requirement when tax is deferred.

The proposal also recommends to capture the retained earnings of an Israeli company that at the time of migration (if it is Israeli by means of having its control and management in Israel) as an immediate deemed dividend mechanism, and to capture future dividend distributions by a foreign company at the hands of a migrating resident, if the tax deferral route was elected by that taxpayer for the distributing shares.

Other anti-avoidance rules are also proposed, such as for the cases where an Israeli migrating company transfers assets from the Israeli headquarter to a permanent establishment in another country, and where a foreign company transfers business from its Israeli permanent establishment to another country. Restrictions are also suggested to apply to a migrating resident who sold assets within four-year period unless the migration was to a treaty country of Israel.

A leniency is suggested with respect to residents who migrated and returned to Israel within a five-year period.

These proposals are expected to have a significant impact and should be carefully monitored.

Tax residency of individuals

Following the review of comparable tax law, the ITA proposes to implement day-count irrebuttable presumptions to classify an individual as an Israeli or foreign resident under domestic law. This will be supplemented with the existing qualitative test on the individual’s center of life, in cases where the quantitative test does not indicate sufficiently the existence or non-existence of the individual’s center of life in Israel.

These tax residency irrebuttable presumptions, together with the exit tax proposals, may have a significant impact on the taxation of individuals, who should follow these developments.

Reporting requirements

As part of the expansion of various reporting requirements, it is recommended to grant the ITA broad powers to require and obtain information from foreign companies that operate in Israel or that serve as a platform for the activity of Israeli residents through it. These reporting obligations may require the foreign company to provide the ITA with information on its activity in Israel, the activity of foreign residents who use the platform to generate income from Israel, and/or on Israeli residents that operate through the platform. The information will relate to customers, types of transactions, scope of transactions and more.

Significant reporting changes are also suggested with respect to New Immigrants and Veteran Returning Residents including their related trusts and corporations, where the reporting on non-Israeli assets and income will generally be required during their 10-year holiday period, even though such income should be tax exempt during that period.

Mandatory Disclosure Rules (MDR)

Consistent with EU DAC6, the package includes an MDR chapter that will apply bi-annual reporting requirements on intermediaries for international arrangements that fall under one or more of the listed hallmarks, similar to those included in DAC6. That said, it is currently suggested to exclude hallmark A (generic hallmarks linked to the Main Benefit test), as Section 131D of the ITO already includes a reporting requirements regarding a tax opinion obtained by a taxpayer under certain conditions, that the ITA considers to be similar.

Branch profit or remittance tax

While the ITA is looking to introduce a new branch remittance or profit tax, it has been decided to further examine this topic as part of a dedicated follow-up committee.


With the significant proposals that are suggested to be introduced in this international tax reform package, companies should closely review this package; consider reviewing their positions with respect to its different elements; analyze reorganizations and simplifications of holding, financing and intangible structures in order to use opportunities and avoid future tax implications; and continue monitoring the developments to be efficiently prepared for these potential changes, once legislated and introduced into the Israeli tax law.


For additional information with respect to this Alert, please contact the following:

EY Israel, Tel Aviv

Ernst & Young LLP, Israel Tax Desk, New York



  1. Assuming the other three conditions are met, including that at least 30% of the company’s shares are listed for trading, that Israeli residents own more than 50% of any means of control of the company, and that the tax rate that is applicable on the passive income in the foreign country is higher than 15%.
  2. Base Erosion and Profit Shifting.

The information contained herein is general in nature and is not intended, and should not be construed, as legal, accounting or tax advice or opinion provided by Ernst & Young LLP to the reader. The reader also is cautioned that this material may not be applicable to, or suitable for, the reader's specific circumstances or needs, and may require consideration of non-tax and other tax factors if any action is to be contemplated. The reader should contact his or her Ernst & Young LLP or other tax professional prior to taking any action based upon this information. Ernst & Young LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.


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