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Review of Withholding Tax Deduction, a Possible Exemption from It, on Payments to a Foreign Resident
Introduction, and the Presented Limitations
In this review, we will present our understanding of core principles, for example, from the law concerning withholding tax deduction, on payments to a foreign resident. This presented understanding may not be accurate, and one should not rely on it, for instance as if it were advice we provided to the reader. Thus, for example, the presentation of this understanding of ours does not include a complete reference to all the different variations of classifying various payments for the purpose of withholding tax deduction, and the implication of payment classification on withholding tax deduction or exemption from the instruction to deduct it.
It should be emphasized that this current review presents general information and does not constitute specific legal or tax advice. It does not address any case on its merits according to the circumstances and the full law, and is not accompaniment by a qualified tax advisor.
Even before the start of this review, we note that it is primarily done from the angle of the Tax Authority’s instruction on withholding tax deduction from a payment to a foreign resident, when parallel to this there are also the angles of the applicability of the instruction in the Income Tax Ordinance regarding withholding tax deduction as stated, as well as the entire set of tax law provisions, including the Income Tax Ordinance and tax laws.
We note that provisions regarding the obligation to deduct may be procedural, and even if essentially, the tax laws do not create a tax liability for the payment, it may be necessary to pay the tax deduction from the payment, or it will be necessary to obtain an exemption from it.
Even before the start of the discussion, we will draw attention to two key questions in the context of withholding tax deduction: what is the economic nature of the payment for its classification purpose, and whether it constitutes income subject to tax in Israel in the hands of the beneficiary.
Withholding Tax Rate on Payment to a Foreign Resident
When there is an obligation to deduct tax at source on a payment from an Israeli resident to a foreign resident, this may currently be expressed as a deduction of about 25% of the payment when transferred to a private individual or a deduction of 23% of the payment when transferred to a corporation, which is according to the corporate tax rate in Israel today. The corporate tax rate may be different and/or change.
Note that since the withholding deduction is only considered an advance on account of the tax liability, there may be a situation where a deduction of 25%, for example, will ultimately be found not to cover the full tax liability of a non-resident individual, should it be determined that they were liable for tax on taxable income related to the payment. For such a matter, there may be tax implications for the payer and/or the beneficiary.
As an aside, we note that there are also cases of liability for VAT payment, upon making a payment from an Israeli resident to a foreign resident, when this is done for certain items, which this current review does not include reference to.
Withholding Tax Deduction, or its Absence, is Not a Final Ruling on Tax Liability
It should be emphasized that a withholding tax deduction, or an exemption from the need to deduct it, does not constitute a final ruling on tax liability, or the absence of such a liability. Meaning, a withholding tax deduction is expected to be considered a type of advance on account of a tax liability, whether it exists or not, and that the payment of the withholding tax deduction, or the absence of such deduction payment, does not prevent a situation where the tax liability will be different from the amount paid as a withholding tax deduction or as an exemption from it.
At the beginning of the review, we also emphasize that a possible obligation for withholding tax deduction from a payment amount, which we refer to, is one that applies to a payment to a foreign resident. That is, for a payment from an Israeli resident payer to someone who is an Israeli resident, even if the account of the Israeli resident beneficiary is located outside of Israel, the provisions regarding withholding tax deduction from a payment to a foreign resident are apparently not applicable, since there is no such payment at all in the present case.
There is Another Obligation for Withholding Tax Deduction on Payment to an Israeli Entity Generating Income
The lack of applicability of the provisions regarding withholding tax deduction on payment to a foreign resident, in a payment made to an Israeli resident, does not concern another category of withholding tax deduction, which is relevant to a payment to an Israeli resident who generated income.
Meaning, the possible absence of applicability of the provisions regarding withholding tax deduction on payment to a foreign resident, in a transfer to an Israeli resident, does not cancel another possible obligation for withholding tax deduction from another category, which applies, for example, to a payment from an Israeli payer to an Israeli entity generating income upon receiving the payment, if that entity does not legally hold its exemption from withholding tax deduction on receipts it receives in a certain income category appropriate for the payment, and this is entirely without connection to the provisions regarding withholding tax deduction on payment to a foreign resident.
Transfer by an Israeli Resident Between Their Two Accounts
A transfer by an Israeli resident, for example, an individual, between their two accounts, even if they are not in Israel, may be one for which no withholding tax deduction obligation applies.
Even if the tax residency of the transferor is unclear, a transfer from a foreign resident to a foreign resident is a category exempt from withholding tax deduction, in a transfer to a foreign resident, as will be detailed below regarding the Tax Authority’s Implementation Instruction 34/93.
But… a transfer by an Israeli resident from their account abroad, may lead to a personal obligation
Note that in the Income Tax Ordinance, the obligation to withhold tax at source for a payment to a foreign resident applies to the payer. Thus, it ostensibly applies to an Israeli transferring from their account abroad to a foreign resident, for whom the receipt constitutes taxable income in Israel. Performing such a transfer was included for several years in a Tax Authority directive regarding the obligation to report to the Tax Authority about a “Reportable Position” concerning the execution of such a payment. It ostensibly appears that the designation of such a position as requiring reporting to the Tax Authority was recently canceled, as can be seen from the Tax Authority document in the link above. The cancellation of an obligation to report does not mean the cancellation of an obligation to withhold tax at source where the legal provision requires it.
Transfer Money Only If You Solely and Fully Own It
When an Israeli enjoys a simple possible money transfer from its bank account in Israel to its bank account abroad, it is important to note that it is transferring only money that it is the full sole beneficiary of. That is because the existence of another beneficiary of such money held in a one’s bank account, beyond the bank account registered owner and its spouse, and especially if full disclosure was not provided in advance to any involved in such holding or money transfer financial institution, might constitute an criminal offense under anti-money laundering law and/or regulation.
Withholding Tax Deduction on Payment to a Foreign Resident is Related to the Receipt Being “Taxable Income”
We also draw attention to the fact that a fundamental question about the aforementioned withholding tax deduction is related to the answer to the question of whether the receipt for the beneficiary constitutes “taxable income” for the purpose of tax laws in Israel. The basis of charge may be that contained in section 170 of the Income Tax Ordinance, which states, inter alia, that “Anyone who pays to a person who is not a resident of Israel, to him or to another on his behalf, any income subject to tax under this Ordinance”.
And yet, we emphasize that the obligation to deduct, unless otherwise determined either by the Tax Authority or by a competent court, is apparently not conditional on the payer’s ability to determine with certainty that there is no tax liability, for example based on their position that the payment will not constitute taxable income.
Inter alia, in accordance with this, the Tax Authority, in its instructions, permitted many exceptions from a general initial obligation it set for financial institutions, including banks, on withholding tax deduction, from any payment transferred to a foreign resident and/or to a beneficiary bank account that is located outside of Israel. This is apparently in order to align with the obligation in the Income Tax Ordinance, for withholding tax deduction, which was specifically designated for a situation where there is “taxable income” for a foreign resident receiving a payment from an Israeli resident payer for tax purposes and/or from a bank account in Israel.
After all, the transfer of funds from Israel to a beneficiary abroad for investment purposes, in itself, apparently does not constitute “taxable income” at all. Similarly, a payment from Israel to a foreign resident entity whose income is not subject to income tax in Israel as “taxable income”, for example on a territorial basis, may, in accordance with a tax treaty to which Israel is a party, also apparently be excluded from the initial rule regarding the instruction to deduct tax at source, from a payment to a foreign resident. Different payment classification tracks may allow for an exemption from the instruction to deduct tax at source, given that ultimately, in a substantive examination, there is no legal obligation to deduct tax at source on the payment to the foreign resident, according to its nature.
Responsibility for Performing Withholding Tax Deduction
The responsibility for performing withholding tax deduction from a payment to a foreign resident rests with the payer. The Tax Authority may view the “payer” as including a financial institution, as that term is defined under the VAT Law, even though the operation performed by financial institutions may be the transfer of funds on behalf of a payer. Hence, the great caution of financial institutions, as defined in the VAT Law, including banks, when transferring funds to a foreign resident, or outside of Israel. This caution may be reflected, for example, inter alia, but not only, in checking whether the beneficiary is an Israeli resident or not, and what the nature of the payment is.
Source of Obligation for Withholding Tax Deduction in the Income Tax Ordinance
The legal source for the obligation of withholding tax deduction from a payment to a foreign resident is set out in Section 170(a) of the Income Tax Ordinance, which states that “Anyone who pays to a person who is not a resident of Israel, to him or to another on his behalf, any income subject to tax under this Ordinance, which is not income from which tax was deducted under Sections 161 and 164, is obliged to deduct from that income, at the time of its payment, a tax of 25 agorot per lira if the recipient of the payment is an individual, and a tax at the rate imposed under Sections 126 and 127 if the recipient of the payment is a body of persons, or another rate that the Assessing Officer shall determine for them in a written notice, but the Assessing Officer may permit the payment of the income without tax deduction, if it is proven to his satisfaction that the tax has already been paid or will be paid in another way…”. The Income Tax Ordinance is in the status of primary legislation of the Knesset of Israel.
Income Tax Regulations – Deduction from Payments to a Foreign Resident
In accordance with this section of the Income Tax Ordinance, the Income Tax Regulations (Deduction from Payments to a Foreign Resident) were established, which granted authority to the Commissioner of Income Tax (as he was then titled) to set a different withholding tax deduction rate than the default rate set in the Income Tax Ordinance, or to exempt from the obligation to deduct it, and also granted him authority to set types of payments to a foreign resident for which there will be no withholding tax deduction liability.
These regulations set a way for the possible granting of an exemption from the aforementioned withholding tax deduction, under the possible authority of the Tax Authority, a certified public accountant specifically authorized for this matter, or a banking corporation, in response to a request from a payer, as submitted on Tax Authority Form 2513/1, which was previously called Form Sam/114, or by means of Form A/114 according to the request of a foreign resident expected to receive payment from an Israeli resident.
Implementation Instruction 34/93 of the Tax Authority to Financial Institutions, Including Banks
In accordance with the authority granted in the above regulations as the source of authority, the Commissioner of Income Tax (as he was then titled) was granted the authority to exempt various types of payments to a foreign resident from withholding tax deduction. Thus, in 1993, “Implementation Instruction” 34/93 was established, which was applied to financial institutions, as defined in the VAT Law, including banks, and according to which they shall deduct tax at source, except for various types of payments as detailed in the instruction, and for which an exemption from the instruction to deduct tax at source as stated was applied. This implementation instruction replaced Implementation Instruction 43/92 from 1992.
We emphasize that there may be a situation where a bank deducts withholding tax, even when the tax law should not have led to a tax charge, and in such a case the payer has the right to request a refund of the payment from the Tax Authority, if all of his advances exceeded his tax liability legally.
Note that since payment card companies (“credit”) in Israel are classified as dealers for the purposes of the VAT Law, and not as a financial institution, this implementation instruction was not applied to them, and therefore payments made with a payment card do not result in a withholding tax deduction upon their execution. In this context, we emphasize that although the credit card company, as it is not a financial institution for the purpose of the VAT Law, was not required to perform the withholding tax deduction, the obligation to perform it, which applies to the payer, may still apply even when not deducted by the credit card company as the transmitter of the payment funds.
In accordance with the instruction, an initial “main path” was apparently set for withholding tax deduction from any payment made, possibly in the context of a payment executed through a financial institution for the purpose of the VAT Law, from an Israeli resident to a foreign resident, which is not of a type for which an exemption was granted within the framework of this instruction. Thus, the instruction contains a long list of types of payments for which such an exemption is granted, but still, types of payments to a foreign resident for transactions with characteristics such that the Income Tax Ordinance apparently did not impose a withholding tax deduction obligation on them, and for which this implementation instruction still did not exempt transfers from withholding tax deduction, may remain outside its scope.
The detail of the types of payments exempt by virtue of the instruction appears in section 3 of the instruction, attached in the link at the beginning of this section, and includes, for example, goods (excluding computer software) for which an import entry was issued or based on a declaration upon import with a value of up to $500 when the import is not for a business or profession, certain international transportation services, tourism services provided entirely outside of Israel, services provided entirely abroad without the service provider being present in Israel and up to a monetary ceiling that may be $250,000 per year per payer (updated amount), advertising expenses abroad, tuition fees paid to a learning institution abroad, rent for private purposes not claimed in Israel as an expense, estates – based on a probate order and/or court confirmation regarding the estate, limited to the amounts attributed to the heirs abroad, gifts and support to relatives as defined in section 88 of the Income Tax Ordinance, allowance for medical travel and expenses for medical treatment abroad, consideration for the purchase of foreign securities, consideration for a single sale of a private vehicle owned by an individual, transfer from a non-resident deposit account (as a bank account in non-shekel currency is called in Israel) to a non-resident deposit account, and more.
This instruction also regulated a method for an “authorized” accountant to issue exemption certificates from withholding tax deduction, but the author is unaware of significant use of such an allowance. Among other conditions that an “authorized” accountant as stated must check compliance with, is their own conviction that there are no “special relations” between the beneficiary and the payer, as defined in this context, which are likely to affect the tax charges, including relations of proximity according to the Income Tax Ordinance, and that there is no single controlling owner who controls as detailed in section 76 in those related companies.
At the end of the instruction, the authority of a local assessing officer to grant an exemption was regulated, for example in a payment for the maintenance of an office abroad and the wages of local employees, when such an office is owned by an Israeli resident paying entity, the exemption authority of the Income Tax Commission headquarters, also for cases other than those mentioned previously, and also for cases where, for example, the payer does not have a “file” with the Income Tax Commission.
The instruction also set out a method for tax refund, for someone from whom excessive withholding tax deduction was deducted, against the final tax liability determined in their matter, to be carried out in the collection department of the Income Tax Commission. Such a refund is conditional, inter alia, on the presentation of original documents regarding the withholding tax deduction, confirming the payment of the withholding tax deduction, which is considered an advance on account of tax, which was deducted at the stage of payment to the foreign resident, possibly outside of Israel.
Exemption from Withholding Tax Deduction Based on Declaration in a Transfer to a Beneficiary in a Treaty Country, in Types of Investment
In September 2017, the Tax Authority announced a declaration track for the transferor, which, given the conditions below, will allow payment to a foreign resident with an exemption from withholding tax deduction, as a “green track”, through which banking corporations will be permitted to perform transfers based on the payer’s declaration, and compliance with a number of conditions.
As stated, the above announcement established authorization for banking corporations to transfer payments to a foreign resident without withholding tax deduction, based on the payer’s declaration, on Form 2513/2 (note: later in this current review we will present a more up-to-date version of the form, which is broader than the original one available in the link presented in this paragraph), subject to the fulfillment of all the cumulative conditions below, and based on the payer’s declaration and the bank’s verification that the data in the form were filled out as required:
1. The payment transfer is to a resident of a treaty country (meaning, a tax treaty exists between Israel and that country) and to a bank account in a treaty country, as stated.
2. The payment is requested to be for one of the following: investment in shares of a body of persons, investment in real estate abroad, investment in other tangible assets (only) abroad, granting a loan to a foreign resident, or granting an owner’s loan to a body of persons.
3. Form 2513/2 was filled out and kept at the bank
and also supporting document(s) are kept, which substantiate the classification of the payment, at least as required on the form.
We draw attention to the fact that in tax treaties, a reference to the right to tax is customary in the context of the location of an asset, and thus it is possible that also in this context, the physical location of the asset in which the investment is made through the payment, in the treaty country and not in Israel, may have weight in the context of the Tax Authority’s determination of the exemption track based on a declaration, when the asset is in a treaty country, and the beneficiary’s bank account is also in a treaty country. In Israeli tax law, a tax treaty is in a status that overrides the specific local tax law.
Note that this list of payment types, from 2017, still did not include, for example, the type of payment for investment in a partnership, as has been recently added to it. This is, for example, the type of payment for the investment of a holder in a Limited Liability Company (LLC) in the USA, when paying money for an investment, as such money is transferred to a bank account owned by the said LLC. We also note that while in the USA there may be transparency between the LLC and an individual who is an owner in it, in Israeli tax law, the LLC is considered a separate corporation from the individual owner in it, and therefore, for example, there is no lack of applicability of the obligation for withholding tax deduction, based on a claim that this is a payment from an Israeli resident to that same Israeli resident, since the LLC in Israeli tax law is not considered equivalent to the Israeli individual themselves.
In Form 2513/2, the issue of the existence or absence of special relations between the payer and the beneficiary must be addressed, in the context of the definition of this term in the Income Tax Ordinance: “Special relations” – including relations between a person and their relative, as well as control of one party to the loan over the other, or control of one person over the parties to the loan, directly or indirectly, alone or together with another;.
Update of Form 2513/2 for Self-Declaration, to Also Include Investment in a Partnership, for example
Starting with the wording of Form 2513/2 from 2018, the possibility for an exemption from withholding tax deduction was included in it, in the transfer of an owner’s investment in a partnership. This is the transfer of an individual to an LLC, of which they are an owner. The update of Form 2513/2 in 2020 also continues to keep this type of payment as allowing an exemption from the obligation set out in the instruction to deduct tax at source. The existence of this type of payment in the above form is what allows payment with an exemption from withholding tax deduction, which otherwise would not be possible except with the approval of the Tax Authority or a court. Thus, a court may determine, possibly in accordance with section 16 of the Interpretation Ordinance (New Version), the lack of legal applicability of the above implementation instruction, as it may be determined to contradict the Income Tax Ordinance, which is at a higher legal level, and possibly also basic laws in their proprietary context, even if it is determined that withholding tax deduction is an advance, since it is possible that the payer may determine in court that they are not liable at all, even for an advance on account of tax for investment activity.
For the case of repayment of loan principal to a foreign resident, the need to use Form 2513/3, signed by an accountant licensed in Israel, was determined.
Special Companies that Received Specific Approval for Transfer with Exemption upon Application of the Law up to a Ceiling
In accordance with the First Addition to Implementation Instruction 34/93 dated January 26, 1998, which is extended from time to time, companies can request specific approval from the Tax Authority to be considered a “special company,” and given approval, to operate the application of the law regarding withholding deduction with independent consideration, up to an annual ceiling of $250,000 for the payer themselves. See in the link, the Tax Authority Announcement dated December 22, 2024, according to which the validity of the above First Addition is extended to December 31, 2025.
Obligation to Verify the Identity of the Payer to Another
A financial institution in Israel serving the one who pays to another may be obligated to verify their identity. Such verification may, for example, be done through a remote conferencing call whose execution process has been legally approved, in a face-to-face meeting, or by a holder of an Israeli license to practice law.
Additional Requirements of Banking Corporations
Beyond the obligation applying to a bank in Israel not to unreasonably refuse to make a payment from the shekel or foreign currency balance in a bank account, in accordance with the provisions of section 2 of the Banking Law (Customer Service), the said bank may be permitted to condition the execution of a payment crossing the border of Israel, and/or a payment to a foreign resident, on receiving explanations, and/or supporting documents, and/or an accountant’s approval, relating to the payment whose execution was requested from the said bank. This is inter alia, for example, in the context of the provisions of the Prohibition of Money Laundering Law, the applicable Prohibition of Money Laundering Order, and compliance with international provisions in the field of money laundering prohibitions resulting from banks holding currencies held for them in foreign countries. Thus, a bank may ask to verify that the payer is legally complying with the tax liability related to the payment whose execution was requested from that bank.
Requests for complementary information may also stem, for example, from international agreements adopted in local law, regarding the sharing of bank information in a uniform format, which are called Common Reporting Standard (CRS). This may stem from the Income Tax Regulations (Implementation of a Uniform Standard for Reporting and Due Diligence of Financial Account Information), 5779-2019, and the bank’s obligation to act in accordance with a legal instruction binding upon it.
Supporting Documents, Upon Delivery of Which Payment to a Foreign Resident Beneficiary and/or Located Abroad, with an Exemption from Withholding Tax Deduction, May Be Conditioned
Thus, payment to an entity considered a foreign resident for tax purposes, including an LLC of which the payer may be an owner, with an exemption from withholding tax deduction may be conditioned, inter alia but not only, on the prior delivery of relevant supporting documents and/or proofs, which may include, inter alia, but not necessarily only, documents from among these documents:
- Tax Authority Form 2513/2 signed by the person requesting to pay
- Bank confirmation regarding the beneficiary’s ownership of their bank account
- Certificate of Incorporation of the LLC (Limited Liability Company)
- LLC Foundation Agreement
- LLC Operating Agreement
- Copy of a valid personal identification document, such as a passport, of each of the partners in the LLC according to the details appearing in each of the LLC documents
- Agreement signed by all parties for the purchase of a real estate asset
- Agreement signed by all parties for granting a loan
- Investment agreement in a tangible asset that is not real estate
- Investment agreement in shares
- Certificate of Incorporation of a foreign resident corporation, possibly certified by an attorney
- Israeli accountant’s confirmation that the payment is for loan principal repayment, and not interest
- Confirmation from an authorized signatory on behalf of the partnership that the transfer of funds to it constitutes an investment
- Document of authorized signatories of a corporation involved in the payment
- Signed agreement for the purchase of options
- Israeli accountant’s confirmation that the payment is for the exercise price supplement for options to shares
- Supplier invoice, including details about the good(s) and/or service(s) provided
- Israeli Tax Authority approval for full or partial exemption from withholding tax deduction
- Israeli Tax Authority confirmation regarding the beneficiary’s and/or payer’s tax residency in Israel
- Official supporting documents that attest to and/or confirm that the payer and/or the beneficiary is a resident of a country other than Israel for tax purposes
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