(photo credit: Courtesy)
Following the 2003 tax reform, Israeli residents are taxable in Israel on their worldwide income. So, who is a resident? We have discussed this in the past but it is worth summarizing the current position. Individuals will be Israeli resident if their center of living is in Israel, having regard to their overall personal, family economic and social circumstances.
Individuals will generally be presumed resident if they are present in Israel 183 days or more in a tax year, or 30 days in a tax year and 425 days in Israel in a particular tax year plus the previous two years. A tax year is the year that ends each December 31. A day includes a part of a day. These "number of days" presumptions can be challenged by the taxpayer or the tax authorities.
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 official bodies, namely the State of Israel, a municipality, The Jewish Agency, Joint Israel Appeal/Jewish National Fund, State-owned company, official or statutory body.
Commencing January 1, 2006, individuals who come to Israel but do not become new immigrants may avoid being deemed Israeli residents if they make the appropriate notification and various conditions are met. This may be applicable to: foreign diplomats and their families; soldiers; students (studying at least half a course, for up to three years); lecturers or researchers at an academic institution; priests (up to three years); hospital patients; foreign journalists (up to five years); and foreign sportsmen (up to five years).
Residency problems commonly occur if an Israeli businessman travels abroad most of the time but leaves his wife and kids at home in Israel. Is his "center of living" in Israel even if his absence is greater than his presence? A recent Israeli court case ruled that for tax purposes each spouse may indeed be considered a resident in a different city if that is how they really live.
A person's tax status is unconnected to the person's immigration status. Unlike some countries, such as the UK, Ireland and Australia, Israel does not have the tax concepts of "domicile" or "ordinary residence."
In addition to the above tax provisions, the National Insurance Institute published a Circular on January 2, 2006 (5/2006) which seeks to clarify when a person stops being an Israeli resident. If a person continues paying national insurance contributions while he is abroad, this fact signifies his intention to retain his connection with Israel and to retain his national insurance entitlement - at least in the first five years.
Is it possible for someone to be fiscally resident in more than one country? Yes, it is. For example, dual residence is established if someone is domiciled in Australia and present in Israel for 183 or more days in a tax year.
Such a person may face double-tax reporting obligations in the two countries and must check his eligibility to foreign tax credits in both countries. This is a balancing act with no easy way out sometimes because there is no tax treaty between Israel and some countries, such as Australia.
Israel has tax treaties with 38 countries (see below) and a few more are on the way. If an individual is considered resident according to domestic law in both Israel and another country that has a tax treaty with Israel, he or she can apply the "tie breaker" test in that treaty to allocate residency to one country only. This can certainly reduce exposure to double taxation (US persons - see below).
Israel has tax treaties with the following countries: Austria, Belarus, Belgium, Bulgaria, Brazil, Canada, China, Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, India, Ireland, Italy, Jamaica, Japan, Korea, Mexico, Netherlands, Norway, Philippines, Poland, Romania, Russia, Singapore, Slovak Republic, South Africa, Spain, Sweden, Switzerland, Thailand, Turkey, UK, USA and Uzbekistan.
What about US persons? They must file federal US income tax returns on their worldwide income and gains, not forgetting US gift and estate tax on their worldwide assets. A US person includes US citizens, US green card holders and US residents (generally individuals resident in the US for a period of time) according to detailed US tax rules. All this is without regard to the fact that they may also be Israeli residents.
Therefore, people who are US persons resident in Israel, must report to the tax authorities of both countries and divide up their foreign tax credits and resulting tax payments according to special rules in Article 26(2) of the US-Israel tax treaty. In our experience, Article 26(2) requirements are not always correctly applied or the affairs of a person are not properly addressed and too much tax is sometimes paid to the wrong government - therefore, specialist advice is recommended.
Here is an example. Suppose a US person, resident in Israel for 20 years, buys publicly traded IBM stock in January 2006, sells it in February 2007 and makes a capital gain along the way. The tax rate in the US is 15% and in Israel, the rate is 20%. Is a tax check payable to: (a) the US government (b) the Israeli government or (c) both governments - double taxation?
The answer is (b) as the tax in the above example is payable to the Israeli government with no double taxation, applying Article 26(2) of the US-Israel tax treaty.
Another safe harbor from double taxation concerns US persons who qualify for a "Section 911 exclusion" (exemption) in the US for non-U.S. earned income of up to $82,400 per year. Earned income covers salary or business profits but not portfolio or passive income. In addition, there is an employer-provided housing exclusion that is tied to the foreign earned income exclusion cap. The base housing amount used to calculate the foreign housing cost exclusion is 16% of the amount (computed on a daily basis) of the foreign earned income exclusion limitation.
An objective standard is applied to determine the amount of reasonable housing expenses. The amount of the exclusion is limited to 30% of the maximum amount of a taxpayer's foreign earned income exclusion. So, the maximum amount of the foreign housing cost exclusion in 2006 is $11,536 [($82,400x30%) minus ($82,400x16%)]. But an "anti-stacking" rule means that any excess is taxed on marginal rates as if the excluded amounts were taxable before giving a credit for Israeli taxes. The US person must be a bona fide resident of Israel (or other country outside the US) or physically present over 330 days in a 12-month period and a taxpayer of Israel (or other country outside the US). Such excluded earned income may be exempt from US federal tax, but still be taxable in Israel.
The writer is an International Tax Partner at Ernst & Young Israel
(With thanks to Ed Rieu of the Ernst & Young U.S. Desk, London)