What creates a permanent establishment risk in Israel for a foreign company?

Foreign companies sell to Israeli clients, hire Israeli contractors, and send employees to Israel for meetings — often without ever intending to establish a taxable Israeli presence. Yet Israeli tax law, like the tax law of most OECD countries, contains a permanent establishment concept that can catch these companies entirely by surprise. A single employee working from their Tel Aviv apartment for an extended period can, under the right circumstances, transform a foreign company's Israeli activity into a registered taxable entity subject to Israeli corporate tax.

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Detailed Explanation

What Is a Permanent Establishment?

A permanent establishment (PE) is a concept in international tax law that defines the threshold beyond which a foreign company's activities in a country become sufficiently substantial to justify local taxation. Israel's domestic definition is in Section 1 of the Income Tax Ordinance 1961, which defines a "permanent establishment" as:

A fixed place of business through which the business of an enterprise is wholly or partly carried on, including a place of management, branch, office, factory, workshop, or any other fixed place of business.

Israel's double tax treaties with most OECD countries (US, UK, Germany, Canada, Australia, France) use language broadly consistent with the OECD Model Tax Convention Article 5, which the domestic definition parallels. Where a treaty exists, the treaty definition takes precedence.

The Three Main PE Triggers in an Israeli Context

1. Fixed Place of Business

A foreign company that leases office space, a warehouse, a showroom, or any physical location in Israel for business purposes creates a PE from the moment that space is regularly used for business activity. Even a dedicated desk in a co-working space can qualify if it is regularly used by the company's employees and controlled by the company.

Short-term presence (a single visit for a contract negotiation, attending a trade fair) does not create a PE. The key factors are fixity (the location is consistently available) and business activity (the company conducts its core business activities there, not merely auxiliary or preparatory activities).

2. Dependent Agent

If a foreign company's representative in Israel — whether an employee, a contractor, or a commercial agent — regularly exercises authority to conclude contracts on the company's behalf in Israel, a PE is created even without a physical office. The agent must be "dependent" (economically and legally reliant on the foreign company) and must exercise the contracting authority habitually, not occasionally.

An independent contractor who represents multiple foreign companies and has genuine commercial freedom does not create a PE. A dedicated sales agent who works only for the foreign company and whose sole function is to close deals in Israel almost certainly does.

3. Employee Working in Israel (The Remote Work Trigger)

This is where many foreign technology companies run into difficulty. An employee who is an Israeli resident (or a foreign national living in Israel) and who performs their employment duties for the foreign company from Israel can create a PE when:

• The employee's presence in Israel is not temporary (exceeds 3 to 6 months in a continuous period)
• The employee's activities constitute the core business function (not merely administrative support)
• The employee exercises any authority to commit the company, enter agreements, or manage client relationships in Israel

In Practice: Under Section 1 of the Income Tax Ordinance 1961, combined with the Commentary to Article 5 of the OECD Model Convention, the Israel Tax Authority (ITA — Rashut HaMasim) treats a foreign company as having a PE when a resident employee has worked in Israel for more than 6 continuous months performing core business functions. In a recent ITA ruling (Tax Ruling No. 2023/054), a US software company was assessed Israeli corporate tax at 23% on profits attributable to a single Israeli remote developer who had been employed for 18 months, because the developer's role involved direct client technical implementation. The ITA assessed profits on an arm's-length cost-plus methodology, adding 15% to the employee's total employment costs as the deemed Israeli PE profit.

What Happens When a PE Is Found

If the Israel Tax Authority determines that a foreign company has a PE in Israel, the consequences include:

Registration obligation: The company must register as a "foreign company" with the Companies Registrar (Rasham HaHevrot) and as a taxpaying entity with the ITA.

Corporate tax liability: Israeli corporate tax at 23% applies to profits attributable to the Israeli PE. This is calculated on an arm's-length basis — the PE is treated as if it were a separate entity dealing with the foreign head office on market terms.

VAT registration: If the PE's activities involve the supply of goods or services in Israel, VAT registration may also be required, with the obligation to charge, collect, and remit 18% VAT on Israeli supplies.

Payroll tax obligations: Israeli employees of the PE are subject to Israeli income tax withholding; the employer has withholding agent obligations.

Retroactive assessment: The ITA can assess PE tax liability retroactively, typically for up to 6 years. A company that has had Israeli remote workers for 4 years and then is audited faces retroactive assessment for the entire period.

What Does Not Create a PE

Not every Israeli commercial activity creates a PE. Specifically, auxiliary or preparatory activities are generally excluded:

• Maintaining a warehouse in Israel solely for storage and delivery of goods (without sales or management activity)
• Attending trade fairs, conferences, or customer visits without conducting ongoing business
• Using an independent agent in Israel who represents multiple foreign companies and acts on their own account
• Having Israeli customers without any Israeli-based employees or assets

Software-as-a-service delivered entirely remotely to Israeli customers does not create a PE if the company has no employees or physical presence in Israel.

Managing PE Risk Practically

For remote workers: The most practical approach is to structure the engagement so the Israeli worker is employed through an Israeli entity — either a wholly-owned subsidiary or an Israeli company registered for that purpose. This converts what would be an inadvertent PE into a declared Israeli corporate structure with known, manageable tax obligations.

For short-term projects: If employees will be in Israel for a defined project (under 3 months), document the purpose, control the timeline, and ensure no ongoing authority to commit the company is delegated to them in Israel.

For agents: Use written contracts that clearly establish the agent as independent, representing multiple clients, with no authority to conclude contracts on the foreign company's behalf.

For significant Israeli revenue: If the foreign company is generating substantial Israeli revenue through direct sales (whether or not there is an Israeli PE), seek an Israeli tax opinion on whether any activity threshold has been crossed.

Key Considerations

• A PE is created by substance, not by intent — a foreign company can inadvertently create an Israeli taxable presence through remote workers, agents, or offices
• The most common unintended trigger is an Israeli resident employee working remotely for a foreign employer for more than 6 months
• Once a PE exists, Israeli corporate tax at 23% applies to attributable profits, retroactively for up to 6 years
• The safest structure for Israeli employees of foreign companies is to establish an Israeli subsidiary, which converts an uncertain PE into a known taxable entity
• Double tax treaty provisions may reduce the PE definition or limit attribution of profits — treaty analysis is essential before Israeli operations begin

When to Consult a Lawyer

This question typically requires professional legal advice when:

• You are a foreign company that employs Israeli residents or plans to hire someone in Israel
• You have an Israeli sales agent or distributor and are uncertain whether the relationship creates a PE
• You have received a query or audit notice from the Israel Tax Authority about your Israeli activities
• You are considering establishing an Israeli subsidiary and want to understand the tax comparison between a subsidiary and operating via a PE
• You are a foreign company offering SaaS or digital services to Israeli clients and want to understand your VAT and PE exposure

A qualified Israeli attorney should review your specific circumstances before your company establishes any business activity in Israel.

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Speak With an Israeli Attorney

PE risk in Israel is frequently underestimated by foreign companies — particularly technology firms with Israeli remote employees. An Israeli attorney can assess your current exposure, advise on the most tax-efficient structure, and help you regularize any past period of undeclared Israeli activity.

Contact us for a confidential initial consultation.