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The year 2005 saw a tidal wave of tax legislation in Israel that will be remembered fondly by business and individual investors, but not trustees and others.
You may not know which side you are on, however, as there has been little publicity or debate regarding the tax changes. This is probably because the changes were enacted by the Knesset at high speed this year, unlike the earlier 2003 tax reform that took 12 years to enact.
In this series of articles, we will review the latest modifications and consider who they will benefit more the taxpayer or the government. We also will keep at the back of our minds that 2006 will be an election year in Israel.
In all cases, readers are advised to consult experienced, professional tax advisors in each country concerned. Appropriate tax planning before the end of 2005 may reap dividends in 2006.
There were two main amendment laws this year.
On July 25, 2005 a broad general tax reform, was enacted in Israel to be effective from January 1, 2006 pursuant to Amendment 147 to the Income tax Ordinance. This followed an earlier reform in 2003 that made worldwide income taxable for Israeli residents. Subsequently, on March 29, 2005, the Knesset passed an amendment to the Law for the Encouragement of Capital Investments, 1959, which revamps the Israeli tax incentives for future industrial and hotel investments.
Letâ€™s start with individuals. The regular graduated rates of income tax for earned income and certain types of investment received by individuals will be reduced. The maximum rate of income tax will decrease from 49% currently to 48% in 2007, 47% in 2008, 46% in 2009 and 44% in 2010 and thereafter.
This reduction is welcome as is the upcoming simplification of tax on investment income. Following the 2003 tax reform, individuals have been taxed in Israel on worldwide investment income and gains at a plethora of rates ranging from 10% to 49%. However, commencing January 1, 2006, the Israeli tax on investment income and gains derived by individuals will be standardized at 20% or 25% as summarized below:
In other words, commencing in 2006, individuals will be taxed at 20% or 25% on most types of investment income but this does not apply to real estate rental income. Foreign taxes will continue to be creditable against Israeli tax, and new immigrants will still enjoy certain temporary exemptions. The government hopes that the 20% tax rate will deter tax planning and resolve various uncertainties.
From January 1, 2007, capital losses from foreign securities may be offset against capital gains from Israeli securities and vice versa. Capital losses then also may be offset against dividends and interest income from securities. Companies, generally, will continue to be taxed at a rate of 25% on capital gains but various technical changes will apply.
Individuals who are US citizens or green card holders residing in Israel will continue to be taxed in Israel and in the US on their worldwide income. Foreign tax credit provisions in the laws of the two countries and the Israel-US tax treaty should prevent double taxation and effectively â€œround upâ€ the combined tax burden to the higher of the tax rates prevailing in the two countries. Experienced tax advisors should be consulted in this regard.
Later in this series we will discuss tax exemptions for new immigrants and foreign investors as well as new investment vehicles in the new law.
The writer is an International Tax Partner at Ernst & Young Israel