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International Taxation

International Taxation

Background

On January 1, 2003, the Income Tax reform became effective within the framework of Amendment 132 to the Income Tax Ordinance. Under the reform, an international personal tax basis was adopted, similar to many States that decided in the recent years to move to this method of taxation from the territorial taxation method.
The territorial taxation method implied that the tax collection in a State is imposed only on the income produced or generated in that State, by either a resident of the State or by a foreign resident. Opposed to the above, the personal taxation method has made a clear distinction between the State residents and the foreign residents: while the resident is taxable on his worldwide income, the foreign resident is taxable only on the income produced or generated in that State. Since each State has its own internal laws, a situation may occur where a taxpayer will be considered a resident of two Contracting States, in each State under its law. Also, when the taxpayer’s income is taxable in both States in accordance with their internal laws, the problem of double taxation may arise. Consequently, the determination of residency and the place of income generation have become crucial, leading to the establishment of a network of tax treaties between many States in the world, aimed to: avoid double taxation, distribute the tax between the State of origin and the State of residence, exchange information between States, encourage bilateral trade, provide certainty in the taxation method and prevent tax evasion.

Residency

When determining the residency of a person considered a resident of two Contracting States, two types of States should be distinguished : * a State having a double taxation avoidance treaty with the Contracting State, * a State not having a double taxation avoidance treaty with the Contracting State . When dealing with a State which has a double taxation avoidance treaty with the Contracting State, the residency of a person shall be determined by the rules set in the tax treaty signed between the two States. Opposite to the above, when dealing with a State that does not have a double taxation avoidance treaty with the Contracting State, the issue of residency and tax liability of a person shall be decided under the international law that bases its decision on assessment of majority of ties. Most tax treaties include a “tie breaker” mechanism that tips the scales when deciding on personal residency. The tie breaker mechanism defined in the treaties is composed of a complex hierarchy of tests, such that if a decision cannot be reached according to the first test, the next test is used.

Tests

The following are the tests for determination of personal residency, used in most double taxation avoidance treaties:
Permanent home test – It is one of the most important tests, and constitutes the basis for assessing a person’s residency, by determining the place of an individual’s permanent residence. The term “permanent home ” is defined as the home owned or possessed by a person, which is available to him and used by him on a regular basis for a long time. If a decision cannot be made we will move to the next test.
Vital interests test – This test examines the mesh of personal and economic relations of a person, and a person will be considered as resident of the Contracting State to which his personal and economic ties are stronger. The term “center of vital interests” is not defined in the tax treaties. Explanatory notes of the OECD clarify that as part of this test the economic, social and personal relations of the taxpayer should be examined, and an assessment to which State he has stronger ties should be made . Also, it is clarified, that these characteristics should be examined as a whole, but the economic actions of the person and his actual whereabouts should not be attributed extra weight, when compared with his personal, family and social ties. If a decision cannot be made we will move to the next test.

Residence test

– The explanatory notes of the OECD clarify that this test is a quantitative test, according to which it should be counted in which State the person resides a longer period during the year. The State where the person lived for a sufficient and longer period, shall be considered as his place of residency. Also, the explanatory notes emphasize that the calculation of length of stay in a particular State does not imply to mean staying in the permanent home only, but any stay in that country. The explanatory notes also define that it is important to question how long the taxpayer is absent between two stay periods. Generally, the tax treaties do not set the period of time during which the comparison has to be made, but according to the explanatory notes it seems that the comparison should cover a period of time long enough to be able to effectively determine if the taxpayer actually used to live in the specific State. If a decision cannot be made we will move to the next test.

Citizenship test

– This test is a purely factual test, it is required to examine the person’s citizenship according to the citizenship certificate held by him. In the event of a person that does not have citizenship in either State or is a citizen of the two States, we will move to the next test.
Mutual agreement – In case where a decision on residency could not be made by the foregoing tests, the issue of residency will be resolved through mutual agreement – a procedure that does not exist among States not having a double taxation avoidance treaty.
Today, the State of Israel has signed double taxation avoidance treaties with about 50 States , as follows: Argentina, Austria, Belarus, Belgium, Brazil, Bulgaria, Canada, China, Czech Republic, Denmark, Estonia, Ethiopia, Finland, France, Germany, Great Britain, Greece, Hungary, India, Ireland, Italy, Jamaica, Japan, Luxembourg, Latvia, Lithuania, Mexico, Moldova, Netherlands, Norway, Philippines, Poland, Portugal, Romania, Russia, Singapore, Slovakia ,Spain, South Korea, Sweden, Switzerland, Thailand, Turkey, Ukraine, Uruguay, USA, Uzbekistan, Vietnam,


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