Your Taxes: Problematic judgment regarding foreign investments

Since 2003 Israeli resident investors have been taxable on income and gains from overseas investments.

August 26, 2014 22:29
House and calculator [Illustrative].

House and calculator [Illustrative].. (photo credit: INGIMAGE)

Since 2003 Israeli resident investors have been taxable on income and gains from overseas investments.

Now it seems the cost of their overseas investments may fluctuate in shekel terms, resulting in a higher or lower Israeli capital gains tax liability when the investments are sold, according to a recent court decision (Clal Finance Batucha Investment Management, Ltd. vs Tel-Aviv 5 Assessing Officer, Civil Appeal in the Tel-Aviv District Court number 13485-02-13, handed down August 13, 2013).

Israel abolished exchange control on foreign investments in 1998. But the latest case may cause a fiscal drag on investments abroad by Israeli residents.

The decision is controversial because it ignores part of the Israeli tax law, as discussed below.

There will be many potential losers and a few potential winners unless action is taken.

Only immigrants and returnees in a 10-year Israeli tax exemption need be unconcerned for the time being.

The court case:

The appellant (Clal) is not a taxpayer, it merely handles investment portfolios for clients that include foreign securities. When clients realize investments, Clal has to withhold tax and a question arose how to withhold tax resulting from foreign exchange losses.

The judge, the much respected Magen Altuvia, reviewed certain Israeli capital gains tax rules the Income Tax Ordinance. The judge ruled that when foreign securities are sold, two assets are actually sold: (1) the security itself and (2) a right to foreign currency.

If there is foreign exchange loss, it cannot be set off against a gain on the security itself. This is because capital losses can only be utilized if a capital gain would have been taxable (ITO Section 92(a)(1)). In the case of foreign assets, only the real gain is taxed in Israel after stripping out any foreign exchange gain.

The implications:

All this may sound technical, but the results may be dramatic. Back in January 2003 the economy was in the doldrums and the shekel was weak. Since then, the economy has picked up and the shekel has steadily strengthened.

For example, the Bank of Israel representative rate for the shekel against the US dollar has moved up from 4.785 at the beginning of 2003 to around 3.5 now – a 27 percent appreciation of the shekel.

Suppose you invested $1,000 in US securities at the beginning of January 2003 and sold them now. According to the Israel Tax Authority and the judgment, your cost for Israeli tax purposes in shekel terms is apparently only NIS 3,500 and not the NIS 4,785 you actually paid back in 2003. So if you just sold those securities for the equivalent of NIS 6,000 it seems the taxable gain may be NIS 2,500 not NIS 1,215.

Is this reasonable?

The court cites the example of Facebook stock. An Israeli investor may gain or lose from both changes in the stock price and in the NIS-USD exchange rate.

Why is the judgment controversial? Unfortunately, the judgment and the parties involved appear to have overlooked part of the law. ITO Section 240A empowers the director of the ITA to determine rules of conversion for translating to shekel income, taxable income, losses, expenses and tax payments of a taxpayer that originate from abroad.

The director duly issued such rules that have the effect of regulations pursuant to Section 240A. Section 7 of those rules state that for the purpose of calculating a capital gain, the original price (=cost) of an asset shall be translated according to the representative exchange rate of the Bank of Israel on the date of acquisition or payment, which is earlier. And the sale consideration shall be translated to shekels at the rate on the date of sale or receipt, whichever is earlier.

This means in the above example the cost for Israeli tax purposes should be NIS 4,785. It is unclear why there is no mention of the Section 240A regulations in the Clal judgment.

Who are the winners and losers?

The potential “losers” from this judgment appear to be any Israeli resident entity or individual or that invested in foreign assets – such as overseas securities or real estate – denominated in a currency that weakened against the shekel over the period of ownership. Currencies that have weakened overall since the beginning of January 2003 include: The US dollar (down 27% as above), pound (down 24%), euro (down 6%), yen (down 16%) and rand (down 42%).

The potential winners from this judgment appear to be any Israeli resident entity or individual that invested in foreign assets denominated in a currency that strengthened against the shekel in the period they owned them.

Currencies that have strengthened overall since the beginning of January 2003 include: The Canadian dollar (up 6%) and the Australian dollar (up 22%).

In specific cases, it is important to check what happened to the exchange rate movements over your actual period of ownership.

What should you do?

If you are a “winner” of this judgment, consider invoking the sale date exchange rate to the cost of your overseas investment for Israeli tax purposes.

If you are a “loser” of this judgment, consider invoking the Section 240A regulations, on your yearly and half yearly Israeli tax returns, to apply the acquisition date exchange rate to the cost of your overseas investments. If the ITA insists on applying the district court judgment, do so subject to the outcome of any more favorable judgment (e.g. in the Supreme Court) that may perhaps emerge in the future.

In all cases professional advice should be taken from investment and tax advisers in each country concerned.

And if you are both a winner and a loser on different investments (e,g, some in the US, some in Australia), multiple choices lie ahead...

To sum up:

It remains to be seen whether an appeal is made against the above judgment will be filed. In private discussions the ITA has admitted the Section 240A regulations may indeed be relevant.... It is fair to assume we haven’t heard the last word on this judgment.

As always, consult experienced tax advisers in each country at an early stage in specific cases.
The writer is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd

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