Your Taxes: Tough tax issues for olim

The Israel Tax Authority (ITA) has just published a tax ruling (number 2597/13) that covers many tricky Israeli tax issues that olim face.

You might think there is a 10-year Israeli tax holiday (exemp- tion) for new residents and senior returning residents who lived abroad for five to 10 years. In fact, the exemption only applies to FOREIGN-source income and gains, leaving an Israeli tax liability from day one for their ISRAELI-source income and gains.

It is true that additional tax credits lessen the blow a bit in the first three and a half years, and Patach foreign-currency deposit interest at an Israeli bank is exempt for five to 20 years. But that still leaves many other issues for unprepared olim.

The facts of the ruling

In 1997, the taxpayer left Israel with his family and took up res- idence abroad in a country that has a tax treaty with Israel. In the second half of 2010, the taxpayer and his family were assigned by his overseas employer to work in its Israeli subsidiary company. After two years back in Israel, the taxpayer decided to continue living in Israel on a permanent basis and applied for a returning residents’ certificate from the Immigrant Absorption Ministry.

In 2009, the employer granted all its employees, including the taxpayer, stock (share) options, but the start of the option vest- ing (entitlement) period was backdated to 2007. The explana- tion for the backdating was that this was the employing compa- ny’s first stock-option plan and it took a while to adopt it.

What did the taxpayer ask the ITA to rule on?

Based on this fact pattern, the taxpayer requested a tax ruling on a range of issues. First, when did he become fiscally resident in Israel? Second, could he request an extension of the pre- scribed 90-day deadline after arrival in Israel for electing to stay a foreign resident for a year for Israeli tax purposes (“settling-in- year election”)? Third, to what extent are stock-option gains tax- able in Israel when they or the resulting stock are sold?

Main aspects of the tax ruling

The ITA took a fairly strict line in the ruling based on their reading of the tax law. First, the taxpayer was ruled to be an Israeli resident entitled to his 10-year tax holiday from the moment he arrived in Israel. The 10-year clock started ticking at the beginning of the two-year initial period of employment before the tax- payer made up his mind to reside in Israel on a permanent basis.

Second, the taxpayer could not be granted a settling-in year because the election wasn’t filed within the 90-day deadline after arrival in Israel as prescribed in the tax law.

Third, the ruling specifies rules for taxing stock options that amplify those in an earlier authoritative tax ruling (number 61/06). Assuming there is no approved Israeli trustee, the ruling says the option benefit is taxable as salary income upon grant if the rights granted are publicly traded, or upon realization if the rights are not publicly traded. But if the options vested in the taxpayer before his arrival in Israel, they are exempt from Israeli tax. If the vesting ends after the individual arrives in Israel, the benefit is taxed to the extent they vested after arrival. This is calculated by counting the days in the vesting period, except for Friday, Saturday, festivals and family vacations.

So by ruling that a person is resident as soon as they arrive in Israel, and taxing option gains that vest while they are Israeli resident, the ITA gets to tax a greater share of the options that vest- ed before and after arrival in Israel.

Comments

It is unfortunate that someone assigned to work in Israel is deemed to be resident of Israel as soon as they arrive, if they later decide to reside permanently in Israel. It seems assignees must exercise powers of prophecy regarding their future in Israel.

One solution may be to file a settling-in-year election in good time, within 90 days after arrival in Israel, on Israeli tax Form 1130. Unfortunately, Form 1130 seems to be hard to find on the ITA website these days. If you want one, send me an email.

However, it is possible to argue the ruling is questionable because Israeli tax law expressly states that an individual becomes resident in Israel when they shift their center of living to Israel, not when they arrive or start working in Israel. Further- more, if the ITA’s position leads to dual residence in Israel and the other treaty country, the individual might seek protection from this under the terms of the relevant tax treaty.

Always check carefully when the vesting period began – apparently in 2007 in this case.

The bottom line is that the Israeli government welcomes olim and senior returning residents, but the ITA approach is more complex.

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

leon@hcat.co Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.