Tax Advice for Foreign Companies doing Business in Israel: Beware of source tax deduction in Israeli tax law!
Foreign companies entering the Israeli market, whether as suppliers of Israeli clients or as subcontractors, tend to disregard the fact that substantial amounts of 25 to 30% can be deducted from each payment they anticipate receiving from their Israeli clients, under the following circumstances:
The foreign (non-Israeli) company has no tax files in Israel (for example because it is exempt from Israeli income and corporate tax under the applicable double tax treaty);
The payment is received from an Israeli tax payer, for example an Israeli company;
Under these circumstances, Israeli tax law requests from the paying (Israeli) party to deduct from each payment 25 to 30% and to transfer it directly to the Israeli tax authority on account of possible corporate tax or income tax payments of the foreign company receiving the payment.
It is important to note that such deduction is made even if the foreign company is not liable to Israeli corporate or income tax under the relevant double tax treaty. In particular, Israeli banks will transfer the source tax deduction automatically with every payment.
Subsequently, the foreign company will have to file a request for reimbursement by presenting conclusive proof that the relevant payment was not taxable in Israel.
The above procedure is intended to secure possible tax payments of every foreign company doing business in Israel.
Companies doing business in Israel can avoid the above difficulties if they request and receive a source tax exemption in advance from the Israeli tax authorities. This procedure is much easier and usually cheaper, than to request reimbursement of assets already transferred to the Israeli tax authority.