Immigration to Israel: Israeli Tax Ramifications and Benefits

By : LEON HARRIS

10 Year Tax Holiday

Israeli resident individuals are subject to Israeli tax on their worldwide income and capital gains.   Effective January 1, 2007, "New residents" and "Senior Returning residents" (Israelis who have lived abroad for at least 10 years ) are both entitled to the same package of tax benefits.

 Returning residents who lived abroad for only 5 years, but who returned from 2007-2009, are also entitled to these same tax benefits.   References to new residents below include senior returning residents, unless otherwise indicated.

 The most notable benefit for new residents is a 10-year tax holiday (exemption) regarding all non-Israeli sourced income and capital gains, even if the foreign assets were acquired after moving to Israel.  

 Exempt income and related assets do not need to be reported to the Israel Tax Authority for the entire 10 years.   All types of income and capital gains are covered by the exemption if they are derived from non-Israeli sources, such as income from salary, business, pensions, investments, etc.

 New residents and senior returning residents also have immunity from rules regarding ‘control and management’ and ‘controlled foreign companies’ and ‘foreign professional companies’.    In addition, they may elect, within 90 days after arrival in Israel, to be treated as non-resident for one year for Israeli tax purposes (explained in more detail below).

 

Waiving the Exemption

New Immigrants are entitled to waive their exemption on passive and earned income.   There are relatively few circumstances where this option is preferable.   But in particular cases, where there is a lack of clarity regarding the taxation of pension income, it may be desired to pay a low Israeli tax, rather than to pay a higher foreign tax.

 

When does Israeli Residency start?

For Israeli tax purposes, an Israeli resident is defined as an individual whose centre of living is in Israel, taking into account the person’s family, economic and social links.

 A rebuttable presumption of Israeli residency will apply in either of the following circumstances:

·         the individual is present in Israel at least 183 days in a tax year ending 31 December, or

·         the individual is present in Israel at least 30 days in the current tax year, and 425 days cumulative in the current and two preceding tax years.

 Aside from the number of days' presence in Israel, the center of living criteria listed in the law are:

·         Location of permanent home;

·         place of residence of the individual and his/her family;

·         place where the individual regularly works or is employed;

·         location of active and material economic interests;

·         place where the individual is active in various organizations, associations or institutions;

·         employment by certain official bodies.

 Since the center of living test is subjective the Israeli Tax Authority (“ITA”) has published additional objective criteria (Circular 1/2011). These criteria deem Israeli fiscal residency to start at the earliest of the following times:

·          At the date stamped on the certificate issued by the Ministry of Absorption or

·          At the date the individual started living in a permanent home in Israel (assuming he does not have a "family" (for example: a spouse and children under the age of eighteen) or

·          At the date any member of his family started living in a permanent home in Israel (in cases where he has a family).

 According to the above Circular, Israeli residency only commences when the individual arrives in Israel with the intention to comply with one of the above alternatives.

 For example, if a foreign resident owns a house in Israel for several years and then decides to make aliyah, that person will not be become resident retroactively when the home was first acquired.  

 No concepts of domicile or ordinary residence exist for Israeli tax purposes.  

  Settling-in year
It is possible to elect to remain a foreign resident for Israeli tax purposes during the first year in Israel by filing Form 1130 for a "settling in year election."   This form must be filed within 90 days after arrival in Israel.   

According to the ITA, the date of arrival is determined to be the earliest of the following:
* the date listed on the Immigration Absorption Ministry new/returning resident certificate;
* the date when there is a permanent home in Israel available for personal use;
* the date the immigrant's family (spouse, children) have a permanent home in Israel,

 * after 183 days presence in Israel.

If the foreign resident has made the election and subsequently leaves Israel during the settling-in year, he will be treated as if he was never an Israeli resident.   On the other hand, if he continues living in Israel at the conclusion of his settling in year, his ten year exemption period begins retroactively (from the time that he first moved to Israel).   In other words, his settling in year counts as the first year of his 10 year tax holiday; he does not receive an extended 11 year tax holiday as a result of his acclimatization election.  

 Furthermore, for an Israeli returning to Israel after 9 years abroad his settling in year will not be counted as the tenth year of his stay abroad.   He will not be entitled to the more extensive aliyah benefits package (granted only to returning residents who have spent a decade abroad) if he only spent only 9 years outside of Israel.

 

Foreign Taxation
New residents should check if they are still taxable in their old country. For example, immigrants from the UK must make a ‘‘clean break‘‘ from UK residency in order to cease being tax resident in the UK.   The clean break concept came to light in the recent Gaines-Cooper court case.  

 US citizens, on the other hand, must keep filing US tax returns, regardless of where they reside.   US Citizens should check with their US CPA's to determine whether they are required to file the FBAR form (report of foreign bank and financial accounts) with the US Department of the Treasury regarding Israeli investments.

 

Dual fiscal residence

Reference to the relevant tax treaty is often helpful when claims of dual tax residency are a concern.   A taxpayer can invoke special ‘‘tie-breaker‘‘ rules in his old country‘s tax treaty with Israel.   The tax treaty prevails over the laws of each individual country.  

For example, Israel‘s tax treaties with both the US and South Africa state that if an individual is an "Oleh" (immigrant holding an Israeli immigration certificate) and his center of living is in Israel, he is deemed to be an Israeli tax resident and is not tax resident in either the US or South Africa.   But the relevant tax treaty should be carefully examined, as tax treaties differ from one another. Israel has tax treaties in effect with over 50 countries.

 

Israeli sourced income
The 10 year tax holiday does not apply to Israeli source income, only to non-Israeli source income of new residents.  When a new resident works in Israel (regardless of where his employer or clients are located) he generates Israeli source income and is liable to pay Israeli tax on that income.  

 For example, if an individual moves to Israel and works by Internet and Skype in Israel for his previous firm (located abroad), he incurs an Israeli tax and national insurance liability. There may also be Israeli corporate tax implications for a foreign employer – this can be overcome if the arrangements are properly structured. Professional advice should be obtained in each case.

 

When a new resident supplies services while outside of Israel, the income is viewed as foreign source income, not subject to tax in Israel, even if the employer is resident in Israel.  

 In Circular 1/2011 the ITA claim that if an Israeli employer relocates a new resident employee abroad for a short period, the resulting income will be considered an integral part of his Israeli employment income and therefore subject to tax.   But the legal basis for making such a claim is unclear.

 

Regular Israeli tax rates
Israeli income-tax rates, when they apply, range from 10% to 45% in 2011.   Top marginal rates are scheduled to decrease each year until they reach a target rate of 39% in 2016.   Dividends, interest and capital gains are taxed at only 20% when under 10% of the investee entity is held, otherwise higher rates apply.  

 

National insurance (social security) rates

National insurance (social security) is also payable at various rates on most types of income up to NIS 73,422 a month (in 2011) as follow:

·          Employees - rates from 3.5% - 12%

·          Employers - rates from 3.85% to 5.43% (5.90%-12.90% from April 1, 2011)

·          Self employed individuals - rates from 9.82%-16.23% (52% of the National Insurance amount paid is tax deductible)

·          Not working - rates from 9.61%-12% (52% of the National Insurance amount paid is tax deductible)

There are no National Insurance fees for most dividends and capital gains.

Income t ax credit points
Most countries grant their resident taxpayers deductions or personal allowances which reduce taxable income.   Israel is different because it grants personal tax credits, which are known as credit points. They directly reduce the amount of tax due, not the amount of taxable income.  

The value of a credit point usually changes slightly each year.   In 2011 each credit point is equal to NIS 209 per month, resulting in an annual tax bill reduction of NIS 2,508 for each credit point.   In the case of a married working couple, the husband usually receives 2.25 credit points and the wife usually receives 2.75 points.   Consequently, their combined 5 credit points will reduce their annual tax bill by NIS 12,540 in 2011.

New immigrants however, are entitled to additional credit points- beyond the standard points mentioned above during their first 3.5 years in Israel as follows:

·          During the first 18 months              -3 additional credit points

·          During the following 12 months    - 2 additional credit points

·          During the next 12 months -           -1 additional credit point

Commencing in 2011, ‘‘returning residents‘‘ (Israelis who have lived abroad six years continuously) will also get the extra credit points according to Amendment 181 to the Income Tax Ordinance.   T his amendment applies to returning residents who return to Israel between May 16, 2010, and September 30, 2012. To ensure receipt of the credit points, the individual must show his documents to his local tax office which then confirms his extra credit point entitlement on Form 101. The individual then hands in Form 101 to his employer. This can also be confirmed in a Returning Resident Certificate from the Immigration Absorption Ministry.

Pensions
Unfortunately, the Israeli tax treatment of certain flexible foreign retirement plans for new residents at the conclusion of their 10-year tax holiday is not entirely clear. But the Israeli tax owed on such plans (US IRA‘s and 401K plans, UK SIPPs, etc.) should not exceed the tax which would have paid in country from which the pension is paid.

 It is critical to check the relevant tax treaty. For example, the South Africa tax treaty generally exempts in South Africa pensions paid to individuals resident in Israel.   Israel will also exempt such pensions during the ten year tax holiday – resulting in a double exemption from tax.

 Furthermore, new residents from the UK face an additional issue during their 10-year tax holiday. According to the current UK-Israel tax treaty, such persons are taxed in the UK on their pensions if they claim the Israeli 10-year tax holiday.   One possible solution is to consider converting the pension, before pension payments begin, to a QROPS - Qualified Recognized Overseas Pension Scheme approved by Her Majesty‘s Revenue & Customs. Alternatively, an individual can wait for a draft new UK-Israel tax treaty (which clarifies this matter) to be ratified and implemented, whenever that may be.

 
  Bank deposits

New residents are also exempt from paying tax on interest income from a “Patach,” account ( Pikadon Toshav Chutz - foreign currency time deposits of at least 3 months at an Israeli bank), for a period of 20 years or for five years if you are a returning resident.   Deposits in non-Israeli banks are covered by the 10-year exemption granted to all non Israeli source income.

 

 

 Dividends from a foreign corporation

Foreign sourced dividends , paid to an Oleh or returning resident, are not taxable during the relevant exemption period.    But Israeli sourced income, even if distributed by way of a foreign corporation, does not qualify for the 10 year tax exemption (due to the fact that it originated in Israel), according to ITA Circular 1/2011.

 

Inheritance or gift from abroad
There is no inheritance tax in Israel, but Israel does impose capital gains tax on the sale of assets.   Many other countries impose inheritance taxes.   As a result, a taxpayer with investments outside of Israel can often find himself subject to double taxation.   For example, a person purchased a home in London for GBP 30,000 in 1975, dies in 2010, and bequests it to his daughter (who is living in Israel).    She then sells the home for GBP 1 million.   The capital gain of GBP 970,000 (recalculated in shekels) will be taxed at Israeli capital-gains tax rates of up to 45%, with no corresponding tax credit given for UK inheritance tax (40%). The result is up to 85% in taxes.  

United States taxpayers living in Israel also need to be concerned about owing US estate taxes (ranging from 35% to 55%) in addition to Israeli capital gains taxes.    There are several possible solutions to this problem of double taxation of inheritances.  

One possible solution is to request concessionary relief from the Israel Tax Authority after the person‘s death.   Another option is to use a trust.   We can elaborate.

Trusts
When a settlor (grantor) of a trust moves to Israel, the trust will get the same 10-year tax holiday for non-Israeli source income and gains, as the new resident, assuming the individual took up Israeli residence   in 2007 or later. Specialist advice should be obtained regarding all trusts.

 

Privileged residents (researchers)

Another category of individuals entitled to special tax exemptions are "Privileged Residents."   These are individuals who first becomes Israeli resident in the years 2011-2015, or who return to reside in Israel in those years after residing outside Israel for six consecutive years. Unfortunately, the status of Privileged Resident has limited applicability.

If a non-Israeli resident is invited to live and work at a recognized Israeli academic institution or hospital, he will be exempt from Israeli tax on royalty income received from an ‘‘application company‘‘ belonging to that institution for five years starting in the year such income is first received. This is applicable as of January 1, 2011, subject to various conditions, as discussed below.

An application company is a subsidiary of an academic institution or hospital that engages in the development of products discovered or developed by the institution or hospital. The individual must enter into an agreement with the applications company within two years after the end of the year in which he/she moved or returned to live in Israel.   Tax avoidance must not be a motive. The agreement should relate to the development of a product in consideration for, among other things, royalties for the usage of the product.

The product should be a tangible or intangible derived from research and development according to a plan approved by the Chief Scientist‘s Office under the Industrial R&D Encouragement Law.

This exemption only applies to the portion of royalties paid by the applications company out of amounts received from a foreign resident that does not have a ‘‘permanent establishment” in Israel.   A permanent establishment is not defined here, but it is usually taken to mean a fixed place of business.

  As always, consult experienced tax advisors in each country at an early stage in specific cases.
© 2011

Leon Harris is a certified public accountant and international tax specialist at Harris Consulting & Tax Ltd

leon@hcat.co