On 17 January 2019 the UK and Israel signed a new protocol to the UK/Israel Double Tax Treaty (Protocol) which provides for a reduction of Israeli tax on dividends and interest, and no Israeli tax on royalties.
More specifically, it reduces the rate of withholding tax on dividends from 15% (as currently provided for in the UK/Israel Double Tax Treaty (Treaty)) to: (a) 0% on holdings by pension schemes; and (b) 5% for companies which hold at least 10% of the share capital of the subsidiary, and it reduces the rate of withholding tax on interest from 15% (as currently provided for in the Treaty) to: (a) 0% on payments to governments, local authorities, central banks or pension schemes, or on bonds traded on a UK Stock Exchange; (b) 5% on payments to banks; and (c) 10% in other cases.
With the forthcoming reduction in dividend withholding tax, the Protocol makes investment into Israeli companies more attractive for UK corporates than it previously has been. Although, where possible, debt funding into Israel is still likely to be preferred to equity funding when taking into account the current 23% Israeli corporation tax rate. Taking the following scenarios as an example:
Scenario A: Equity Investment
For these purposes we have assumed that receipt of the dividend is not taxable in UKCo’s hands on the basis that it is an exempt distribution.
IsraeliCo will be subject to tax on its profits at 23%, giving a tax bill of 46 which, when added with the withholding tax of 5, gives a total of 51.
Scenario B: Debt Investment
For these purposes we have assumed that IsraeliCo will benefit from a full tax deduction on the payments of interest it makes to UKCo.
IsraeliCo will be subject to tax on its profits, less available deductions, at 23%, giving a tax bill of 23.
UKCo will pay tax on the interest income it receives at 17%, giving a tax bill of 15.
The tax bill equals 39 which, when added with the withholding tax of 10, gives a total of 49.
The other changes introduced by the Protocol update the Treaty to bring it closer to the latest OECD recommendations. For example, in-line with the UK’s current approach towards anti-avoidance in its international tax treaties, the Protocol introduces a new BEPS-compliant “principle purpose” test, stipulating that treaty relief is not available if it is reasonable to conclude that obtaining relief was one of the principle purposes of any transaction or arrangement giving rise to the relief unless granting relief would be in accordance with the treaty’s object and purpose.
In the words of Mel Stride (Financial Secretary to the Treasury) the changes set out in the Protocol are designed to “facilitate UK investment into Israel by removing tax barriers to cross-border trade”. Our Israeli clients might see the same as being true of their investment into the UK. Whatever can be said about the Protocol, its implementation should only be a positive change.