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Following is a selection of frequently asked questions by potential olim contemplating a first-time move to Israel.
Q: Should I sell my house outside Israel before I make aliya or afterwards?
A: From strictly a tax perspective, there is no pressure to sell your house prior to making aliya. As a new resident in Israel, the sale of the house you owned prior to becoming an Israeli resident will be exempt from Israeli capital gains tax for 10 years after you have become an Israeli resident. If the house is sold after 10 years, a pro-rata exemption will apply to the gain according to a special formula based on your period of ownership. The proportion ending 10 years after arrival is exempted.
You should also consider the taxes that may be applicable in the country where the house is located.
As far as purchasing a home in Israel, there is no particular rush. The beneficial rate of acquisition tax of 0.5% (up to a monetary limit, instead of up to 5%) applies to new "olim" from one year prior to their arrival to seven years after becoming a new "oleh."
Q: What financial planning is advisable for passive income?
A: There are various Israeli tax exemptions for new residents that relate to the income or gains of assets held before arriving in Israel as residents. Sometimes it is beneficial to implement tax planning before arrival in Israel, especially with regards to the following:
* Foreign investments
* Securities and real estate
* Israeli investments, especially securities
In practice a mixture of trusts, companies, long-term investment instruments, and PATACH foreign currency accounts at Israeli banks are usually considered depending on family circumstances and needs. You should also consult licensed financial advisers regarding the selection of investments.
Q: What are the tax implications/issues of a commuter?
A: We assume you are referring to a case in which a family arrives in Israel and a spouse flies back regularly to the "old country" for business reasons. It will first be necessary to ascertain the residency of the commuter and his/her spouse. The date they became Israeli residents is essential in figuring out when their new resident exemptions begin and end.
Additionally, a commuter may be considered resident in more than one country. If so, it will be necessary to refer to the tie breaker tests in the applicable double-tax treaty.
There are a number of Israeli tax benefits granted to new residents for a limited period after becoming Israeli residents. For instance, an exemption from "business" income may be granted for the first four years after becoming an Israeli resident on income from a business that the taxpayer had abroad for at least five years prior to first becoming an Israeli resident. Therefore, it may sometimes be possible for a commuter who owns a business abroad to request an exemption for "business" income for up to four years if that person conducted a similar business prior to becoming an Israeli resident.
As regards to specific rules that apply to commuters, it should be noted that different tax regimes apply in Israel depending on whether the individual is (1) an Israeli resident employed abroad for over four continuous months by an Israeli employer (2) an Israeli resident working abroad in other circumstances (foreign employer, self employed etc.) (3) non-Israeli resident individual.
Q: Is it advisable from a tax perspective to work a certain number of days abroad?
A: Effective January 1, 2003, an Israeli tax reform law clarified the definition of residency for tax purposes, subject to any applicable tax treaty. Individuals will be 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 year plus the previous two years. Therefore in practice someone may be resident if he or she is present in Israel over 141 days a year (for three consecutive years). A day includes a part of a day. These presumptions are refutable by the taxpayer or the tax authorities.
If an individual does not want to be considered resident in Israel and consequently subject to worldwide tax in Israel, he should avoid being present in Israel 141 days a year. However, as mentioned above the number of days test is refutable by the ITA. Therefore, even if someone is in Israel less than 183 days in a tax year, or 30 days in a tax year and 425 days in a particular year plus the previous two years, the ITA could claim that their center of living is in Israel and that therefore they are actually resident in Israel.
Q: What are the tax implications of a telecommuter?
A: We assume you are referring to someone who works on their computer in Israel for a non-Israeli resident employer. Anyone who is resident and works in Israel - on their computer or otherwise - will be taxable in Israel on their worldwide income. And the employer should check whether the employer is doing business in Israel via that individual - if so, the employer may also be liable to Israeli income tax (and VAT) on their Israeli source business income.
Q: How are pensions and social security payouts to Olim taxed?
A: In the first five years, pensions from abroad should be exempt from Israeli tax for the first five years after becoming a new Israeli resident. However, they may be liable to tax in the source country - it will be necessary to refer to the relevant tax treaty.
After the first five years, once again, it will be necessary to check the relevant tax treaty. Generally, non-Israeli pensions will be taxable in Israel if that is where the individual recipient is resident. According to the US-Israeli treaty, US pensions will only be taxable in Israel, except for governmental pensions, which are only taxable in the US. According to the Canada-Israel treaty, if one receives their pension from Canada, it may be taxed where the individual is resident i.e. Israel. Additionally, there is a 15% maximum rate of Canadian withholding tax on periodic pension payments originating from Canada and paid to an Israeli resident. There are exceptions where a 25% Canadian withholding tax may apply.
Subject to any tax treaty, Israel generally does not tax income when derived by a bona fide pension fund, however subsequent distributions therefrom are taxable. Such distributions may be considered earned income, as this generally includes a pension paid by a former employer, a pension paid by a provident or pension fund in respect of employment, and a lump sum received upon retirement etc. Such income is subject to tax at standard Israeli individual tax rates of up to 49% (48% in 2007).
According to special rules, the Israeli tax on a pension received by an immigrant to Israel, whose source is outside of Israel and is paid for work outside of Israel, will not exceed the tax that would have been payable in the country where it is paid if he remained a resident of that country. For example, for an ex-US resident the tax rate will be capped at the amount of tax that would apply in the US on such a pension. It seems this benefit generally only applies to new immigrants, and not returning residents.
Alternatively, if the taxpayer has reached retirement age (generally 64 for a woman and 67 for a man), 35% of their pension/annuity will become exempt from tax, leaving 65% taxable at regular Israeli tax rates of up to 49% (48% in 2007) resulting in an effective Israeli tax rate of up to 31.85% (31.2% in 2007).
The taxpayer may choose each year between the available alternatives.
Q: What about US Individual Retirement Accounts (IRA) and Canadian Registered Retirement Savings Plan (RRSP)?
A: According to senior officials at the Israeli tax authority, an IRA or an RRSP may be treated as a pension for Israeli tax purposes if the payouts are predetermined. However, if the beneficiary can vary the payouts, the IRA or RRSP will be subject to Israeli tax as if it were a mutual fund.
If the plan is treated as a pension fund, the pension distributions will be exempt from Israeli tax for the first five years. Afterwards, one can choose to between paying the amount of tax applicable in the old country of residence or the 35% exemption if over retirement age, as explained above.
If the plan is treated as a mutual fund, the income element (but not the capital) will be taxed in Israel at a rate of 20%, after the expiry of the five year exemption period.
Q: What about social security pension payouts?
A: Generally social security payments paid by another country will be taxable in Israel. The US-Israeli treaty exempts social security payments from being taxed by both countries.
Q: What are the tax ramifications of an inheritance from the US?
A: The US-Israel treaty does not deal with the US taxes on gifts and estates. If not planned well, an inheritance from the US left to an Israeli resident can be subject to double taxation. The assets of the US resident relative donor may be subject to US estate tax of up to 46% (2006 rate) upon their death and may be subject to Israeli capital gains tax upon a subsequent sale by the Israeli resident recipient.
There is no provision in the Israeli tax law allowing a credit for US estate tax paid against Israeli capital gains tax upon a subsequent sale of up to 49% in certain cases. Also there is no provision that would "step up" the cost basis of the assets to market value for Israeli tax purposes - the recipient assumes the donor's cost basis. Israeli capital gains tax, which ranges from 20% to 49%, will apply on the capital gain arising from the sale of the assets. The result may be combined taxes at a total of up to 95%.
In addition, the capital gain will be calculated for Israeli tax purposes in new Israeli shekels and adjusted for inflation according to the Israeli consumer price index. Only the post 1993 inflationary gain is exempt - an additional 10% tax will be imposed on the pre-1994 inflationary gain.
In many cases there is no intention to sell the principal assets concerned - often the family home and perhaps securities.
Therefore, if the donor settles a lifetime or testamentary trust for the benefit of an Israeli resident, that may help avoid double taxation, assuming certain conditions are met and the trust is considered a tax privileged Foreign Resident Settlor Trust (FRST) for Israeli tax purposes.
Alternatively one may consider a lifetime sale which would apparently trigger US capital gains tax of 15% presumably and a cost "step up" for Israeli tax purposes to fair market value thereby reducing the double tax exposure.
Another alternative is to request relief in a tax ruling from the Israeli Tax Authority. Such relief may sometimes take the form of a revaluation to market value of inherited assets for foreign estate/inheritance tax purposes upon the death of the donor.
Instead the intention is to transfer the future ownership by Will to the benefit of the children. In this case, it may be prudent for you to consider a trust or testamentary trust.
Q: Is it advisable for certain individuals to declare Aliya as opposed to staying on resident status?
A: Generally, from a tax perspective it is irrelevant whether one makes aliya, rather what is important is whether an individual is resident in Israel.
However in borderline cases where an individual may be viewed as resident of two countries (according to the domestic law of both countries), it will be necessary to refer to the "tiebreaker" tests in the relevant double tax treaty. In certain treaties, such as Israel's tax treaties with the US and South Africa, there are provisions stating that in the case of a person who is an "oleh,"his center of vital interests (and residency) shall be deemed to be in Israel.
On the other hand, certain tax benefits related to purchasing real estate such as a reduced rate of acquisition tax (0.5% up to a monetary limit) may be dependent on an individual being an "oleh."
The writers are international tax specialists at Ernst & Young Israel.