When I was young, my parents took me to see the theater production "Fiddler on the Roof." In a wedding scene, some guests in convivial spirits ask the Rabbi if there is a blessing for the Czar of Russia. "Why sure," he replies, "May the Lord bless and keep the Czar... far away from us!"
Some people apply the same principle to tax matters - they keep all tax matters far away and out of mind indefinitely. This is the head-in-the-sand approach and it offers little comfort if (a) you get caught or (b) you file your tax returns but pay more tax than is strictly necessary.
In this article, we briefly review some of the basic principles of wealth preservation from the tax perspective.
When it comes to investing, your goal is to maximize the after-tax returns while deducting any losses and borrowing costs. And, since you can't take your wealth with you into the next world, another long-term goal is to transfer wealth - when you're ready - to your family or other designated persons.
But your investments may be subject to estate or inheritance tax in a number of countries - the US (45%), Canada (24%-25%), the UK (40%) and most European countries - even if you live in Israel.
Currently, Israel imposes a uniform rate of tax of 20% on dividends, interest and capital gains from most investments in publicly available securities and bank deposit interest. Higher rates apply (25%-48%) to pre-2005 capital gains from foreign securities, pre-2003 capital gains on other securities and any securities if you are a securities dealer or you happen to hold 10% or more of any means of control of the portfolio company concerned. There may also be a National Insurance (social security) liability at various rates (0% to over 16%) in certain circumstances.
That's before taking into account any foreign tax if you are a foreign resident or US citizen or green card holder or if your investments are located abroad.
Can these taxes be avoided? What is needed is a general understanding of the tax basics, a review of any legitimate tax-planning techniques and advice from competent tax advisers in each country.
Tax planning falls into two main categories: short-term planning and longer-term planning.
Short-term planning may typically take the form of reducing the overall tax rate and/or deferring the tax liability on re-invested income. Both Israeli and foreign taxes should be taken into account. It may include:
* Five-to-10 year exemptions in Israel for new or returning residents.
* People thinking of moving to Israel may consider establishing an overseas investment vehicle before their arrival to help optimize such tax benefits. But use of certain companies in an offshore or onshore country that does not have a tax treaty with Israel is reportable, under new tax shelter rules. It is vital to obtain specific tax advice.
* Foreign tax credits in Israel for Israeli residents who incur foreign federal or state taxes, but not city taxes.
* Investing in mutual funds if you don't want to select the specific portfolio securities and don't want to pay tax before they pay you income or gains.
What about long-term planning? In essence, there are several scenarios that require long-term planning, as discussed below.
* Yuppie - someone young at heart and on the way up. He/she lives hand-to-mouth and should make every effort to save at least some part of his monthly income. For Israeli-approved employment-related plans - retirement provident funds (kupot gemel) - employers' contributions are generally exempt and employee contributions may qualify for a 25% or 35% tax credit within prescribed limits.
* Middle-aged - a careful, middle-aged investor may not only save pennies but also invest more than a few dollars. This may be the time to consider wrapping securities investments in an appropriate life insurance policy or an appropriate mutual "fund of funds" or a pension plan with sub-funds for different types of investments, among other things. Tax and insurance/pension advisors should be consulted in each country concerned.
In Israel, the tax rate on bona fide recognized life policies and mutual funds may arguably be deferred and limited to 20% of income when eventually distributed to investors/beneficiaries.
In other cases, income may be taxed at rates of 30% to 48% (plus national insurance where applicable).
* Just sold a business or inherited a fortune - At this point, a thoughtful person will re-assess living requirements, investments and estate succession plans. You want to ensure that your children and grandchildren can live well but cannot waste the wealth. This is a classic non-tax reason for establishing a family trust. If an Israeli resident settlor (grantor) contributes assets to a trust, the trustee will need to report and pay tax annually in Israel like an individual taxpayer - i.e. at 20% on most securities income and bank interest, at different rates on real estate income. Exemption is possible in certain circumstances only if the trust assets are located abroad and (a) all the beneficiaries are non-Israeli residents or (b) the settlor (grantor) is a foreign resident and the beneficiaries have no control or influence over the conduct of the trust. Additional rules and aspects may apply so get specialist advice in each country.
* Retirement - Fixed pension payouts may be taxed at regular rates ranging up to 48% (plus national insurance where applicable). However, for foreign fixed-pension plans, it seems people of pension age (67 generally), or survivors, may enjoy an exemption on 35% of such payouts. New residents may enjoy an exemption for pension receipts (if any) in their first five years in Israel, followed by tax at a rate not to exceed the tax they would have paid in their old country. Variable plans such as US IRA plans and Canadian RRSP plans are typically treated by the Israeli Tax Authority like mutual funds, i.e. 20% tax on the income element distributed - if known!
* Gifts and charitable contributions - You can give a charitable donation to a charity if it is a "public institution" approved under Section 46 of the Income Tax Ordinance. In this way, you can claim an Israeli tax credit for 35% of such donations, up to NIS 4 million a year. There is no Israeli gift or inheritance tax, but recipients receive assets at your cost, with no revaluation ("step up"). Gifts to foreign residents are immediately subject to capital gains tax.
In addition, the US-Israel tax treaty allows US persons to claim a US tax deduction for donations to Israeli charities of up to 25% of adjusted gross income from sources in Israel. And an Israeli resident can claim an Israeli tax credit for donations to a US "friends of Israel" charity of up to 25% of taxable income from US sources.
* In all cases - appropriate professional advice should be obtained in each country from legal, tax and investment advisors. Also, make sure you and your spouse have valid wills specifying what you want to happen to your wealth after you go. Otherwise the law will step in, but in a slow expensive way known as intestacy.
Finally, manage the family fortune well using a "family office." You may prefer to run the family office yourself or you may turn for advice and assistance to a number of interested parties - trust companies, banks and so forth. However, if your wealth exceeds $2m. or $3m., consider a virtual family office consisting of a trusted team - independent investment adviser, accountant and lawyer. If your team is smart and proactive, their benefit to you should outweigh their cost.
The writer is an International Tax Partner at Ernst & Young Israel.