Re: Tax Treaties Prevail Over Section 18(e) of the Ordinance
When a company or business makes a payment to a Foreign Resident, and the payment constitutes taxable income for the recipient (and where several additional conditions are met), an obligation to withhold tax at source from the payment generally applies.
A company or business that keeps books using an accrual basis accounting method, records its expenses in its financial statements independently of the date of payment of the expense, such that a situation could arise where asymmetry is created between the date on which the expense is recognized for the Israeli company and the date on which tax is withheld at source for the Foreign Resident.
The Israel Tax Authority wished to save itself from empty pockets, and by legislating Section 18(e) of the Ordinance, a parallel was created between the date on which the payer is authorized to deduct the expense for tax purposes, and the date on which the State receives the tax from the Foreign Resident eligible for the income, through the withholding tax at source mechanism.
Despite this, aspects of a Foreign Resident’s tax liability in Israel are often subject to a treaty for the prevention of double taxation (provided such a treaty is relevant and in force under the circumstances of the case). Furthermore, the Income Tax Ordinance, as well as Israeli caselaw, stipulate explicitly that a treaty for the prevention of double taxation, as above, prevails over Israeli law.
The treaties for the prevention of double taxation Israel has entered into with certain states include a non-discrimination article, which serves primarily to anchor the rule of non-discrimination between the tax treatment applicable in certain circumstances to an Israel Resident and the tax treatment applicable under the same circumstances to a Foreign Resident (according and subject to the specific non-discrimination arrangement and its conditions).
In our opinion, there are quite a few cases in which application of a treaty to a certain case of payment to a Foreign Resident, prevents the application of Section 18(e) of the Ordinance, such that in these cases there would be no need to defer the date of recognition of the expense, even if tax was not withheld at source from the income according to the provisions of the Section.