The Nefesh B'Nefesh Aliyahpedia

Israel, the hi-tech “mecca” of the Middle East, with extensive domestic and foreign resources including skilled labor, is an attractive location for the establishment of new businesses and the transplantation of existing enterprises. The entrepreneur who wishes to develop a business in Israel should consider a variety of factors. The types of business formats and the decision-making process for determining which form is most appropriate will be addressed, generally, in this article.

If you are considering conducting a business in Israel your first decision is whether to begin as an employee (i.e. “עובד”), an independent contractor (i.e. “עצמאי”) or in your own business entity. Most people would likely distinguish an employee from an atzmai based on the form of payment made to the individual since an employee will typically receive a “salary” together with a pay stub (i.e. “תלוש משכורת”) while an atzmai is required by law to issue a tax receipt (i.e. “חשבונית מס”) to acknowledge payment received. In general, that quick summary is accurate although Israeli courts have held that the method of payment is not the sole, determining factor and there are others that could overcome the presumption of the method of payment[1].

It is important to note, although not often realized by entrepreneurs, that regardless of the business form, certain types of businesses require business licenses which, when issued, may include restrictions or conditions to the approval. Examples of some of the types of businesses that require operating licenses from the local municipality include: the sale of alcoholic beverages, peddling goods if from a stand rather than in a building, game facilities, kindergartens, exercise facilities, body piercing/tattoo shops and theaters.

Opening Tax Files. All business entities must open files (i.e. “תיק” or “tik”) at the Value Added Tax (aka “VAT” - i.e. “מע"מ”) and Income Tax authorities (i.e. “מס הכנסה”) unless an exemption applies. The tax files are typically opened by the business’ accountants. In order to open the files, the applicant must supply a blank check of the business and, therefore, it is necessary to first open a bank account. After the business is formed, the lawyer for the enterprise prepares certified copies of the formation documents (i.e. Articles of Incorporation and Certificate of Incorporation), and drafts appropriate protocols granting signatory authority after which the documents are filed with the bank of choice to open an account and order checks. It typically takes 1 week to 10 days to receive the printed checks.Once the business provides the accountant with a check from the business account and a copy of lease for office space, she prepares the application forms and submits them to the tax authorities. The files are typically opened within a matter of days from the time that the application is submitted.Based on the above it is reasonable to expect that tax files could be opened within 3 to 4 weeks of the initial consultation between the business representatives and their lawyer.

In order for one to be able to issue the tax receipts, the independent contractor must open up a tax file with the tax authorities. The contractor must submit a check together with the appropriate application forms to the tax authorities. The registration is typically done by the applicant’s accountant – “unfortunately” a lawyer’s involvement is not necessary.

Once a file is opened at the tax authorities, various reporting requirements are triggered – principally the filing of monthly V.A.T. payments, annual tax returns/financial statements and the periodic Capital Disclosure (i.e. “הצהרת הון”) which is typically required by the tax authorities every 5 years.

Even in those business forms for which a lawyer is not essential, all business forms involve contracts – your friendly (or not), neighborhood (or not) lawyer should draft or at least review those contracts. Similarly, supply contracts, leases and commitments to third parties should be reviewed by your attorney.

One may ask, what difference it makes whether a person is considered to be an employee or an independent contractor. Some of the significant distinctions between the 2 include the following:

(i) Employees are entitled, by law, to social benefits generally including (1) vacation pay (i.e. “דמי חופשה”) ; (2) sick pay (i.e. “דמי מחלה”) ; (3) travel expense to and from work (i.e. “נסיעות”) ;( 4) relaxation pay (i.e. “דמי הבראה”) ; (5) minimum, statutory notice of termination (mutual); (6) severance pay (i.e. “פיצויים”) ; (7) overtime pay (there are exceptions); (8) breaks during the day; (9) statutory penalties for late payment of salary (i.e. “הלנת שכר” ; (10) statutory notice of employment terms (i.e. “הודעה על תנאי עבודה”) ; (11) statutory notice of termination of employment (i.e. “הודעה מוקדמת”) ; (12) statutory statement confirming employment period post-termination (i.e. “אישורלעובד על תקופת עבודתו”) ; (13) a pension (e.g. “פנסיה” or “ביטוח מנהלים”) ; (14) prohibition against sexual harassment (i.e. “הטרדה מינית”) exist generally, the employer-employee relationship is particularly susceptible to violation and, therefore additional restrictions and procedures apply to the relationship; and (15) maternity/paternity leave and rights (i.e. “חופשת לידה”);

(ii) Employees are dedicated to a particular, exclusive or near exclusive employer;

(iii) Employees are subject to the supervision and direction of the employer’s personnel;

(iv) Intellectual property of employees which is created in the context of their employment is deemed to belong to their employer;

(vi) While both employees and independent contractors are often required to sign non-disclosure (e.g. confidentiality) agreements, non-competition agreements and assignment of intellectual property rights agreements, the need to do so is more crucial with respect to independent contractors;

(vii) The Labor Court tends to be pro-employee such that employee benefits can be more easily protected by pursuing claims in this court; and

(viii) Employee rights and obligations are often reflected in a formal employment contract (generally, contractor relationships are as well).

Generally, with the exception of foreign workers, a written contract is not necessary to create an employer-employee relationship. A court would look at the totality of the circumstances to determine whether an employment relationship was established. Nevertheless, employers are required to provide employees with statutory notice of employment terms which list the material terms of the relationship. It is, notwithstanding, advisable from both the employer’s and employee’s perspective for their relationship to be concretized in a definitive agreement that sets forth the details, rights and mutual expectations of the parties – the employment contract is typically prepared by the employer’s lawyer (i.e. “advocate” or “עורך דין”) and it is advisable that the employee have her lawyer review it before signing.

As noted above, an independent contractor is required to issue official tax receipts for payment (which the recipient can use as a taxable expense) for which the contractor must open tax files with the tax authorities.

The relationship between the contractor/service provider and their customers/ clients should be reflected in a definitive agreement prepared by your lawyer.

Advantages	Disadvantages
1.Inexpensive to form	1.Unlimited Personal Liability[3]
2.Less expensive to issue financials	2.Constraints in Raising Capital
3. Less “regulated” – no board of directors, General Assembly, no approvals required of Companies Registrar	3.By its nature its growth potential is limited at least unless or until converted into a different business form
4.Much easier to transfer/sell your business	4. Perception as less serious/ substantial
5.Direct taxability of the business’s profits
6.Subject to U.S. self-employment tax

While not within the scope of advice that I normally provide, as noted in “Disadvantage #6” above, self-employed individuals are generally subject to U.S. self-employment tax (some may consider that a benefit but I put that feeling aside for these purposes). The U.S. (and, after Israel’s last tax reform, Israel as well) applies universal taxation to its citizens (i.e. unless an exemption applies, U.S. citizens are required to report income and pay applicable taxes on income earned throughout the world – even if they are no longer resident in the U.S.). While treaties between the U.S. and Israel may avoid double taxation, it is important to be aware that Self Employment Tax (i.e. social security) is payable for self-employed individuals in Israel. This is yet another reason why some individuals choose to incorporate their businesses and then become salaried employees of their companies. You are advised to consult with your tax advisor for applicability of the tax rules, exemptions and requirements of structuring your business.

If the decision is made to conduct a business in a form other than a sole-proprietorship[4], and assuming that you intend to operate your venture in order to make a profit[5] and, therefore, an NPO or עמותה is not relevant for consideration in this article[6], the main categories of business affiliations include: (a) joint venture, (b) partnership and (c) company.

A joint venture is a contractual arrangement between two or more parties/entities to cooperate towards a common goal[7]. Under some circumstances, the venture will form a mutual, joint venture company that is intended to be the vehicle through which the venture operates. The participants in the venture can be individuals, companies or partnerships. One of the main distinctions between a joint venture and a partnership is that a joint venture is typically established to address a particular issue or project – when that issue or project is resolved, the venture will typically end. Another distinction between joint ventures and partnerships is that partnerships are often created a separate legal entities while the joint venture does not (unless it forms a specific vehicle through which it performs).

The parties to the joint venture will “bring to the table” their own contributions whether it be funding, technology, relationships with third parties or business.

While not indispensable to the formation of a joint venture, prospective members would be well advised to consult both with lawyers and accountants with respect to the structure of the conglomerate, drafting of the joint venture agreement, tax ramifications[8] and allocation of risk/profits between the parties.

Partnerships (i.e. “שותפויות”) are separate, legal entities which can acquire rights and liabilities and which has contractual capacity. Partnerships generally provide a pass-through of income to their partners (i.e. owners) although they generally do not insulate their partners nor managers from liability. Partnerships can be General Partnerships (in which case every partner is personally liable for the liabilities of the partnership) or Limited Partnerships (in which there must be at least one general partner who has unlimited, personal liability while limited partners can have limited liability but may not participate in management of the partnership).

Israeli partnerships must be registered at the Partnerships Registry. Their membership is limited to 20 members.

Partnerships will need an accountant to manage their books and prepare tax returns. They also require lawyers to prepare the partnership formation documents not to mention deal with contractual relationships, employment matters, etc.

Companies (i.e. “חברות”) are the Israeli equivalent of corporations and are the most common form for a business enterprise. Companies are the most recognized vehicles for investment, both by prospective investors and even the Israeli government (which may provide financing grants) – that familiarity makes the investment process glide more smoothly.

One of the most attractive features of the corporate form is that shareholders (i.e. owners) and managers/directors are generally subject to only limited liability for the obligations of the company.Businesses that are targeted for growth, which anticipate seeking outside financing and which wish to retain earnings, will usually choose a company as their vehicle.

Companies are separate legal entities which have contractual and tortious capacity and liability.

Shareholders exercise their right to vote in the context of the company’s General Assembly (i.e. “אסיפה כללית”). Shareholders do not, generally, participate in day to day management of the company – at least not in their capacity as shareholders[9]. It is the company’s Board of Directors (i.e. “מנהלים”), sometimes acting through designated officers, who run the company on a daily basis. The Board of Directors will typically grant signatory authority (i.e. “זכויות חתימה”) – often, although not necessarily, to members of the board. The signatory authority can be with different levels and for different activities, can be joint or individual, can be for banking activities, all activities or particular activities and often must be accompanied by the company’s stamped or printed name.

Shareholders of a company are individually taxed on earnings which they receive from the business in the form of dividends while the company is taxed, at the generally lower corporate tax rate, on its net income. Companies can, therefore, accumulate working capital and equity for long term growth rather than distributing all of their net income to shareholders in the form of dividends which are then taxable to the shareholders.

Where businesses expect to seek fundraising abroad, particularly in the U.S. and/or which anticipate international sales, they generally will establish a “parent company” abroad with an Israeli wholly-owned subsidiary serving as the research and development arm of the business notwithstanding that, in recent years, there have been several success stories of businesses which operated solely as Israeli companies. Raising capital can be done through either debt or equity transactions. While not within the scope of this article, a company need be concerned about the intricacies of various securities laws (and sometimes the securities laws of more than one country) with respect to the solicitation of prospective investors/shareholders (e.g. no public offerings, as defined in the applicable securities laws, without having filed an appropriate prospectus/registration statement with the securities authority, no offering (not sale) to more than 35 offerees).

The liability of shareholders can be expanded through “lifting” or “piercing” the corporate veil (i.e. “הרמת מסך”). The courts will generally only do so in unique circumstances – when shareholders have done something significantly inappropriate such as misrepresenting the company (or its financial condition) in a fraudulent manner, misappropriating tax withholding, commingling of business and personal assets/activities, failure to pay the company’s annual registration fee at the Companies Registrar and failing to file the company’s annual reports with the Companies Registrar[10].

Members of companies’ boards of directors owe a duty of care to the company as well as a duty of loyalty. Shareholders have a duty of fairness to the company.Breaches of these duties may give rise to liability on the part of the individuals.Some of directors’ liability can be addressed via insurance coverage, indemnification or waiver.

All companies must be registered with the Israeli Companies Registrar by (i) execution of an application, Articles of Incorporation (i.e. “תקנון”) and various declarations by the prospective company’s directors and shareholders and (ii) paying a registration fee. When signed in Israel, the documents must be signed in the presence of an Israeli lawyer but if signed abroad they must be executed at the local Israeli consulate, by Apostile, in accordance with the Hague Convention or in the “consular chain”. The registration process is handled by the company’s lawyers.Opening tax files for the company is usually the task of the company’s accountants.

An Israeli company’s records at the Companies Registrar, include its corporate information (such as address, registered purpose, share capital, shareholders’ names, ID numbers, addresses and shareholders’ holdings in the company, directors’ names, addresses and ID number, registered liens, outstanding registration fees and corporate resolutions). All of these records at the Companies Registrar are accessible to the public. Companies are required to notify the Companies Registrar upon material changes in the company including the transfer/issuance of shares, appointment or dismissal of directors, imposition of liens, etc.

Lawyers are necessary to form companies, to set up bank accounts for the business and, it is advisable to consult with them with respect to contractual relationships, labor law matters, leases, etc. Accountants typically arrange to open the tax files.

Comparison Between Companies and Partnerships
Companies	Partnerships
1.Separate legal entity	1.Separate legal entity
2.Shareholders, generally, have limited liability	2.Partners, generally, have unlimited liability
3.Shareholders, generally, taxed only on dividends distributed to them and/or salary income and pay tax on both	3.Partners, generally, are taxed based on the partnership’s income regardless whether reaches the pockets of the individual partners
4. Articles and resolutions direct the company’s acts	4. Partnership Agreement and partners’ decisions direct the partnership’s acts
5. Easier to do tax planning due to ability to retain earnings for working capital since not all income attributed to shareholders	5. Less flexibility for tax planning although tax losses of the partnership can be more easily used by partners due to flow through

A business which is already operating outside of Israel may consider establishing a presence in Israel in one of three forms: (a) appointing a local representative/agent, (b) opening a local branch office and registering with the Companies Registrar as a “foreign company” or (c) forming or acquiring an Israeli subsidiary. Considerations include the extent to which the business wishes/plans to expand, the extent to which it wishes to have its own personnel “on-site”, tax implications and exposure to liability.

Similarly, some businesses consider operating part or all of their business enterprises via “offshore” entities – most particularly in so-called “tax havens”. With the changes in Israel’s tax scheme over the past several years, it is dubious that offshore entities can provide the same benefit which they did previously (to the extent that they did legitimately). Conducting business through an off-shore entity has significant risks and is abundant with complex issues.

There are numerous incentive programs available to businesses – each with their own advantages and disadvantages. While the subject could be the focus of an entire, independent article, we take the opportunity to highlight some of the most relevant programs:

(a) Investment Incentives.Israel’s Law for the Encouragement of Capital Investment (1984) sets 2 general types of investment programs:

(i) Grants for businesses that are awarded to “approved enterprises” which are in a development (priority) area (e.g. Development Area A or Front Line Area);

(ii) Tax Benefits Programs for businesses that are designated as “privileged enterprises” with respect to investments in certain fixed assets in industry;

(i) Domestically via the Office of the Chief Scientist for qualifying technologies which generally range from 20% to 50% of an approved budget;

(ii) Domestically through technological incubators, the Heznek Seed Fund, the Tnufa Program, Magnetor, Noffar and the Magnet Program;

(iii) through Bi-National Funds (such as BIRD between Israel and the U.S., CIIRDF between Israel and Canada, BRITECH between Israel and Britain and VISTECH between Israel and Australia);

(iv) international agreements with countries such as Austria, Belgium, Germany, France and China as well as through participating in multi-national projects such as the EU (e.g. the Seventh Framework Program for Research and Technology Development).

Israel, as the democratic star of the Middle East, is an ideal location for establishing business relations. We look forward to welcoming you to our ranks.

This article is not to be considered as a legal opinion. For legal advice, we suggest you contact legal counsel directly

Russell D. Mayer is senior partner at the Jerusalem-based law firm of Livnat, Mayer & Co. If you have any comments or questions with respect to this article, please contact Russell at mayer@livmaylaw.co.il. All rights reserved © 2009

[1] e.g. even if a person is paid “as if” she were an independent contractor, if she works full time for that business, on their premises, has a supervisor, has little independence of action and receives benefits of an employee, that person may very well be considered to be an employee from a legal perspective – if it looks like a duck and quacks like a duck, a court is likely to consider it a duck even if it is called a lion

[2]compared to companies or other business forms

[3]See in contrast below with respect to companies

[4]essentially an עצמאי notwithstanding that the term typically applies to a service provider

[5]and, therefore, an NPO or עמותה is not relevant for consideration notwithstanding there are Olim who come with the intention of operating an NPO

[6]notwithstanding there are Olim who come with the intention of operating an NPO

[7]the parties allocate responsibilities, tasks and benefits

[8]tax advice is typically within the purview of Israeli accountants

[9]e.g., shareholders can and often do serve as directors – they can affect the company’s day to day activities in their capacities as directors

[10]the above are examples only as it is not within the scope of this article to delve into all the details