Exchange-rate tax measures – will they work?

Your Taxes: A good deal of Israel’s exports go to the United States, so the dollar-shekel exchange rate is of critical importance.

By LEON HARRIS

MAY 17, 2011 21:59

shekel versus dollar 521 (photo credit: REUTERS) — shekel versus dollar 521

(photo credit: REUTERS)

Sometimes tax is used as a way to solve problems. Al Capone was arrested and put away because he forgot to pay tax on his gains. And in a totally different context, the Israeli government is about to apply fiscal brakes to the soaring shekel exchange rate.

A good deal of Israel’s exports go to the United States, so the dollar-shekel exchange rate is of critical importance. At the time of writing, the dollar-shekel representative exchange rate published by the Bank of Israel was NIS 3.485. But in recent years, the shekel has appreciated and the dollar has dropped. The average dollar exchange rate was 4.48 in 2005, 4.45 in 2006, 4.10 in 2007, 3.58 in 2008, 3.93 in 2009 and 3.73 in 2010.

This matters a lot to Israeli exporters, especially hi-tech start-ups. Suppose an Israeli firm breaks even if it generates sales of $1 million. If the exchange rate is 4.5, that means there is NIS 4.5m. to pay the salaries and rent. If the exchange rate strengthens to 3.5, there will only be NIS 3.5m. to pay the salaries and rent.

What should that firm do? Fire about 25 percent of its employees? Or put up its dollar selling prices to customers by about 25% in the hope they will continue buying? Perhaps they’ll switch to a competitor and stop buying Israeli products altogether, meaning all the employees must be laid off? The exchange rate also matters on the import side. If the shekel strengthens, Israelis can buy more cars and stereos from abroad.

New Israeli tax measures

With all this in mind, last Wednesday the Knesset Finance Committee approved regulations that will revoke various exemptions for foreign residents on capital gains arising from certain Israeli government bonds.

These exemptions were originally to encourage foreigninvestor activity in the Israeli capital market; without them, Israeli tax applies at a rate of 15% (if not index linked) or 20% (if so linked) or company tax, as applicable.

However, there was concern that the exemption was being used by players on the foreignexchange market, intending to make short-term gains and causing currency appreciation that may impair the long-term competitiveness of the Israeli economy.

This was mainly regarding purchase of short-term Bank of Israel debt (makam) and short-term government bonds.

Therefore, the Knesset Finance Committee agreed to repeal the exemption for foreign residents regarding capital gains derived indirectly from state loans bearing a date of maturity of no more than 365 days from the issue date; that is, via mutual funds and futures transactions.

The elimination of this exemption will apply from July 7, giving foreign investors the opportunity to consider what action to take. After this date, such income will be subject to tax.

To complete the picture, it was announced that the finance minister intends to propose an amendment to Israel’s related primary legislation (Section 97(B2) of the Income Tax Ordinance), to also revoke the exemption for foreign residents on a direct sale of short-term state loans and to amend the tax regulations accordingly.

Comment

It remains to be seen whether these tax measures will dampen the appreciation of the shekel. Israel has tax treaties with 50 other countries, and foreign residents may sometimes claim an exemption from Israeli capitalgains tax under some of those treaties.

However, it may prove necessary to apply to the Israel Tax Authority for confirmation of treaty eligibility for such an exemption. This may take time, and the ITA will probably check whether the investors are “pros” conducting an investment business in Israel via a “permanent establishment”; if they are, no exemption would apply.

On the other hand, many foreign investors will be indifferent to the new Israeli tax measures because they will often be able to claim double tax relief in their own country of residence; if so, they may continue driving up the shekel... time will tell.

leon@hcat.co

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