Your Taxes: Proposed Israeli tax reform for new residents

This reform will presumably increase the population, and it will provide an alternative to the economic downturn sparked by the subprime credit crisis.

By LEON HARRIS
olim 88 224 (photo credit: Ariel Jerozolimski)
olim 88 224
(photo credit: Ariel Jerozolimski)
Israel is about to celebrate its 60th anniversary. And in high spirits the government has just proposed a tax reform intended to attract more people around the world to immigrate to Israel (aliya) or return to Israel if they left the country. This reform will presumably increase the population, which presently numbers around 7.2 million. And it will provide an alternative to the economic downturn sparked by the subprime credit crisis. The new tax proposals for olim and returning residents are contained in an announcement issued by the Israel Tax Authority on March 13. High hopes are expressed. According to Finance Minister Ronnie Bar-On: "The tax reform for new and returning residents will stimulate aliya and bring back Israelis living abroad, including academics and business people, strengthen the Israeli economy and encourage it to grow." According to Immigration Absorption Minister Ya'acov Edri: "This program is a historic breakthrough that will make it possible for many Jewish people around the world and hundreds of thousands of Israelis living abroad to come to Israel without worrying about the financial side." What is proposed? Following is a summary of the latest tax proposals: • Ten-year exemption: It is proposed to grant olim a broad 10-year exemption from tax for overseas assets and income of all types from foreign sources, including dividends, interest, rent, business and professional income, salary and capital gains. In other words, both active and passive income and capital gains from foreign sources would be covered by the exemption. If enacted, this proposal would be a substantial improvement. Currently, passive income from dividends, interest, rent, royalties and pensions are exempt from Israeli tax for five years after becoming an Israeli resident if they relate to foreign assets held before becoming a resident; capital gains on such assets are exempt for 10 years; income from a business conducted abroad for five years before becoming an Israeli resident may be exempt for four years after becoming a resident. • Returning residents: According to the proposals, returning residents may also enjoy the 10-year exemption for foreign income, but only if they qualify as an "immigrant for income tax purposes." This will generally apply to someone who lived abroad for at least 10 years after leaving Israel. However, the qualifying period would be "only" five years in 2008 and 2009 if that person was a foreign resident on January 1, 2008. Currently, returning residents enjoy the existing five- or 10-year exemptions for foreign source dividends, interest, rent, royalties, pensions and capital gains if they resided permanently abroad at least three years and acquired the assets while residing abroad. • Acclimatization: An "acclimatization period" is proposed. For one year after arrival in Israel, an individual can elect to be considered non-resident for Israeli tax purposes. This is to give the individual time to make up his mind where to reside. Currently, an individual is considered a resident if their center of living is in Israel. It seems this test will continue, but be modified by the above one-year "acclimatization period." • Control and management: At present, subject to any relevant tax treaty, a foreign company is resident and taxable in Israel on its worldwide income if its business is "controlled and managed" in Israel. According to the proposals, foreign companies will no longer be classified as Israeli resident (and fully taxable in Israel) merely because their shareholders make aliya. Instead, foreign-source income of the company would be exempt from Israeli tax under the proposals. Nevertheless, Israel would continue to impose tax on income generated in Israel by the foreign company (and the foreign tax position will need to be checked). • Less tax reporting: Under the proposals, individuals and companies under their control won't have to file Israeli tax returns covering exempt foreign source income. But Israeli-source income will be reportable and taxable under the usual Israeli rules. Initial comments Following are a few preliminary comments coming to mind at this stage; things may be clarified soon: • Effective date: It is not mentioned in the announcement. Also, it is unclear whether olim and returning residents already in Israel may enjoy the new proposed exemption for any remainder of the 10-year period after becoming Israeli residents. • Next steps: The proposals in the announcement are brief and expressed in lay terms. The next steps are to draft a bill and submit it to the cabinet and Knesset. The intention is to give priority to this process. It remains to be seen what will be enacted and how soon. • Beneficial? The proposed 10-year exemption for active and passive foreign-source income is welcome. But care is still needed. • Foreign pensions and retirement plans: The most glaring omission in the proposals concerns foreign pensions and foreign retirement plans; the Israeli tax treatment after the expiry of the proposed 10-year exemption is unclear. The present tax law situation is a mess and the Israel Tax Authority has yet to deliver on promises since 2002 to sort it out. Israeli pension and retirement reform may clarify the tax treatment for planned similar Israeli products. Pensioners who immigrated to Israel cannot turn back the clock when they see the outcome; they can only leave Israel, or obtain specialist advice as soon as possible. • Post arrival assets: It is unclear if the proposed 10 year exemption will cover assets abroad acquired AFTER becoming an Israeli resident. • Returning residents: It may become necessary to reside abroad five-10 years, compared with only three years now, to obtain a foreign-income and capital gains exemption. So expect less returning residents, not more. • Telecommuters: People who do business in Israel for a foreign company, perhaps using the Internet, will make the foreign company taxable in Israel on its Israeli-source profit. The individual will also be taxed on his/her salary or other compensation unless the proposed 10-year exemption for foreign earnings applies. • Trusts: They are not mentioned in the proposals. Under a new tax regime implemented in 2006 in Israel, if a foreign settlor (grantor) of a trust makes aliya or is a returning resident, the trust will become taxable in Israel but enjoy the same temporary exemptions as the settlor. Presumably, this will include the new proposed 10-year exemption for foreign source income and gains. Numerous double-tax and retroactive-tax issues remain regarding trusts for multinational families. To sum up, Israel wants to make aliya and returning to Israel less taxing. But this has not yet been enacted and some issues remain, so advance planning will be needed. Happy 60th anniversary Israel and Israelis everywhere. As always, consult experienced tax advisors in each country at an early stage in specific cases. leon.harris@il.ey.com Leon Harris is an international tax partner at Ernst & Young Israel.