Your Taxes: The new tax treaty with Germany

Israel announced on August 24 that it has signed a new tax treaty with Germany.

Israel announced on August 24 that it has signed a new tax treaty with Germany. It still needs to be ratified by the Knesset and the German Parliament and is expected to become effective on January 1, 2015.

Tax treaties are intended to promote international trade by eliminating double taxation. The new Israel-German tax treaty also contain stronger anti-avoidance provisions and information-exchange provisions.

The new treaty will supersede an existing treaty between the two countries that was signed in 1962 and amended by a protocol in 1977.

The new treaty applies to residents of Israel and Germany.

Israeli taxes falling within its scope include income tax, company tax, profit tax on financial institutions and land appreciation tax. German taxes falling within the scope of the treaty, at the federal and regional (land) levels, include income tax, corporation tax, trade tax, capital tax and the supplements levied thereon.

There are a number of changes, and they are discussed here:

Exemption for Holocaust payments

Under the new treaty, an exemption will apply to various Holocaust-related payments. These are referred to as recurrent or non-recurrent payments by a state as compensation for political persecution or for an injury or damage sustained as a result of war or of military or civil alternative service or a crime, vaccination or similar event.

There are new rules dealing with Israel’s gas discoveries. If a company from one country (e.g., Germany) has a drilling rig or a ship used for natural-resource exploration that lasts more than 12 months, it will have a taxable “permanent establishment” (i.e., branch) in the other country (e.g., Israel).

Israel is defined as the State of Israel as well as maritime areas over which Israel exercises sovereign rights or jurisdiction in accordance with international law and Israeli law.

International law means the United Nations Convention on the Law of the Sea of December 10, 1982.

Withholding taxes

The withholding tax on dividends will decrease from 25 percent under the old treaty to 10% in most cases under the new treaty, or even 5% if the recipient is a company that holds at least 10% of the capital of the company paying the dividends. But a 15% withholding-tax rate will apply to distributions made by real-estate investment trusts to shareholders with less than 10% of the payor company’s capital The withholding tax on interest payments will generally decrease from 15% under the old treaty to 5% under the new treaty. Zero withholding tax may apply under the new treaty to government-insured trade credit, bonds listed on a stock exchange in one of the two countries and interest paid to a pension fund.

The withholding tax on royalties will decrease from 5% in most cases under the old treaty to zero under the new treaty.

Capital-gains taxes

A loophole regarding capital-gains tax will be closed off. Under the old treaty it is possible for an investor from one country to avoid tax in the other country on a sale of shares in a property company in that other country. This is provided the assets of the company are not exclusively real property situated in the other country, or assets accessory thereto or material for the administration thereof. So use of a German holding company to hold shares in an Israeli property company can sometimes be tax efficient under the old treaty.

Under the new treaty, a sale of shares in a company will no longer be exempt if more than 50% of the value directly or indirectly is derived from immovable property (real estate) in the country of residence of the company.

Double taxation

The rules for avoiding double taxation have been revamped. Israeli residents will under the new treaty merely enjoy a foreign tax credit afforded to them by the domestic Israeli tax law. Individual dividend recipients will no longer be able to claim an “underlying” credit for German federal and regional taxes of the company paying the taxes.

Information-exchange rules are upgraded but still a bit vague. The “supplying agency” shall be obliged to ensure that the data supplied are proportionate to the purpose for which they are supplied. The receiving agency must inform the person concerned unless the data were supplied spontaneously (i.e., not requested). Upon application, the person concerned shall be informed of the supplied data and its use.

Comments

Investors from one country who invest in the other country should calculate the combined tax burden in the two countries under the old and new treaties. In some cases it may pay to wait until the new tax treaty takes effect because of its lower withholding-tax rates.

Israeli individuals who receive dividends from Germany may prefer to do so in 2014 to claim the “underlying” credit for German corporate tax of the company paying the taxes.

As always, consult experienced tax advisers in each country at an early stage in specific cases.