I live in Australia and own an Israeli company. Does the ATO tax me on its profits before I take a dividend?

Australian founders and investors with an Israeli company usually plan around the Israeli tax rate and the treaty withholding rate, then are startled at the end of the Australian financial year to find income in their return that never reached their bank account. Australia's controlled foreign company regime does not wait for a dividend. It looks through the company, decides how much of its profit is the kind Australia is unwilling to let sit offshore, and assesses you on it.

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Detailed Answer

Part X of the Income Tax Assessment Act 1936 divides foreign jurisdictions into listed and unlisted countries, and only seven are listed: Canada, France, Germany, Japan, New Zealand, the United Kingdom and the United States. Israel is not among them, so an Israeli company falls into the unlisted category where the attribution net is cast widest. Three control tests can bring the company in: five or fewer Australian residents each holding at least a 1% control interest and together holding at least 50%; a single Australian entity with an associate-inclusive control interest of at least 40% and nobody else in control; or de facto control by five or fewer Australian entities regardless of percentages. Once the company is a controlled foreign company, the active income test decides how much is attributed. Pass it, by keeping tainted income below 5% of gross turnover, and there is generally no attribution. Fail it, and your share of the adjusted tainted income is included in your assessable income under Division 7 of Part X for the year it arises. Tainted income is the passive and related-party category: interest, dividends, royalties, rent, certain capital gains, and sales or services income derived from Australian associates. An Israeli operating company selling software to unrelated customers worldwide will normally pass. An Israeli company holding an apartment in Netanya, a share portfolio or licensed intellectual property will normally fail.

The Israeli layer runs in parallel and is unaffected by any of this. The company files with the Israel Tax Authority (Rashut HaMasim) and pays corporate tax at 23%, so on NIS 1,000,000 of Israeli taxable profit the Israeli bill is NIS 230,000, with the annual return on Form 1214 due by 31 May following the tax year. Israeli tax paid by the company is creditable against the attributed amount in your Australian return through the foreign income tax offset, which softens the outcome without curing the timing problem: Australia taxes you in the year the profit arises, while the cash may stay in Israel for years. When the dividend eventually comes, previously attributed income is not taxed a second time in Australia, and Israeli withholding on the distribution is capped by the Australia-Israel double tax treaty, in force since 6 December 2019, at 15% generally and 5% for a corporate shareholder holding at least 10%, against Israeli domestic rates of 25% or 30%. A separate and larger risk sits alongside all of this. If the Israeli company's real decision-making happens at your kitchen table in Melbourne, it may be an Australian tax resident under the central management and control test rather than merely a controlled foreign company, which is a worse result on both sides of the ledger. Our answer on running an Israeli company remotely as an Australian owner deals with that exposure, and the Australia-Israel tax treaty sets out the rate table in full.

In Practice: Israel is an unlisted country for Part X of the ITAA 1936, so a controlled Israeli company that fails the active income test (tainted income of 5% or more of gross turnover) has its adjusted tainted income attributed to Australian controllers with a 10% or greater associate-inclusive interest, in the year it arises and without any distribution. The company still pays 23% Israeli corporate tax to the Israel Tax Authority (Rashut HaMasim), so NIS 1,000,000 of Israeli profit carries NIS 230,000 of Israeli tax, with Form 1214 due by 31 May after the tax year. Dividend withholding is capped at 15%, or 5% for a 10% corporate holder, under the treaty in force since 6 December 2019. An Israeli pre-ruling on the company's tax position typically takes 4 to 8 months.

When to Consult a Lawyer

• The Israeli company holds Israeli real estate or investments rather than trading. That is the classic active income test failure, and the attributed amount can exceed the cash the company actually generates in the year.
• Your Israeli company qualifies for a reduced Israeli rate such as a Preferred Technological Enterprise. A 12% Israeli rate leaves a much larger residual Australian liability on attribution than the headline 23% does, and the planning needs to be done before the structure is fixed.
• You are the only real decision-maker and you sit in Australia. Company residence, permanent establishment and controlled foreign company analysis interact, and the order in which they are applied determines which country taxes the profit first.

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Speak With an Israeli Attorney

We work with your Australian adviser on the Israeli side of the structure: the company's Israeli tax position, its residence and substance in Israel, and the withholding treatment when profits are finally distributed.

Contact us for a confidential initial consultation.