Your Taxes: Will tax law for new residents spark aliya?

Here is a summary of the main provisions of the new law.

By LEON HARRIS
taxes good 88 (photo credit: )
taxes good 88
(photo credit: )
The Knesset passed a major tax-reform law for new and returning residents last Tuesday. The aim of the Finance and Immigrant Absorption ministries is to encourage a new wave of immigration to Israel during the country's 60th anniversary year. Following is a summary of the main provisions of the new law: New residents - new law People who became Israeli residents for the first time on or after January 1, 2007, will enjoy an exemption from Israeli tax on income and capital gains accrued or derived outside Israel or from assets outside Israel, unless they request otherwise. This does not apply to income or gains from assets received as an exempt gift (i.e. from Israeli resident relatives or other Israeli residents in good faith) on or after January 1, 2007. Notwithstanding the above, such people may elect within 90 days after arrival in Israel to remain a foreign resident for Israeli tax purposes in their first year in Israel - a "settling-in year." (Anyone arriving after January 1, 2007, but before the publication of the new law (expected soon), has 90 days from the publication date to elect a settling-in year, if desired.) The settling-in year may be helpful if they want to enjoy exemptions available to foreign investors (Israeli-listed securities, Israeli R&D-intensive companies, etc.). But the first year does not stop the 10-year exemption clock from running if they stay in Israel. Exempt income does not need to be reported on a tax return. Assets located abroad (not gifted by Israeli residents) do not need to be reported on any capital declaration requested by the Israel Tax Authority. 'Senior returning residents' - new law "Senior returning residents" are treated the same as new residents. A senior returning resident is an individual who returned to Israel to reside after being a foreign resident for: (a) at least five consecutive years if they return to Israel in the tax years 2007-2009; (b) at least 10 consecutive years if they return to Israel after 2009. Other returning residents - new law A "returning resident" will enjoy an exemption from Israeli tax as follows: (a) exemption for five years for non-Israeli-source income from a pension, royalties, rent, interest and dividends derived from assets acquired by that person while that person was living abroad as a foreign resident; (b) exemption for five years for non-Israeli-source dividends and interest derived from foreign "privileged securities" managed at a banking institution. (These are essentially securities traded on a foreign stock exchange or foreign orderly market acquired and deposited at the banking institution while that person was living abroad as a foreign resident AND dividends, interest and capital gains derived on or after January 1, 2007, from such "privileged securities" and reinvested at the banking institution before or after returning to Israel.); (c) exemption for 10 years for capital gains derived from assets acquired abroad while a foreign resident, including "privileged securities." For these purposes, a returning resident is someone who ceased to be an Israeli resident on or after January 1, 2009 (not 2007), and returns to become an Israeli resident after being a foreign resident for at least six consecutive years. Other new residents - old law Other new residents will continue to enjoy an exemption regarding income and gains from assets acquired abroad while a foreign resident as follows: (a) four-year exemption for income from a business the individual had abroad for at least five years before becoming an Israeli resident; (b) five-year exemption for non-Israeli-source dividends, interest, pension, royalties and rent unrelated to a business; (c) 10-year exemption for non-Israeli-source capital gains. Other returning residents - old law Other returning residents will continue to enjoy an exemption regarding income and gains from assets acquired abroad while a foreign resident as follows: (a) five-year exemption for non-Israeli-source dividends, interest, pension, royalties and rent unrelated to a business; (b) 10-year exemption for non-Israeli-source capital gains. (This applies to an individual who ceased to be an Israeli before January 1, 2009, and resided abroad on an ongoing basis for at least three years.) Additional general provisions The definition of "resident of Israel" has been clarified in the case of individuals. An individual continues to be considered a resident if that person's "center of living" is in Israel. This is assumed to be the case, unless proven otherwise, if a person is present in Israel: (1) at least 183 days in a tax year, or (2) at least 425 days over three years, including 30 days in the last of those years (a day includes part of a day). But commencing January 1, 2007, individuals who leave Israel will only shake off their Israeli residency status if they are abroad at least 183 days for two successive tax years and their center of living is abroad for two further tax years. Israel has anti-avoidance rules aimed mainly at non-Israeli tax-haven companies, but these rules will not apply to new and senior returning residents in their 10-year exemption period, unless they request otherwise. These anti-avoidance rules relate to companies controlled and managed in Israel, controlled foreign companies (CFCs) and foreign professional companies. This raises interesting possibilities for avoiding similar rules in other countries. For example, Joe Cohen is resident in the US (or Canada or the UK among others). His son Ephraim has just immigrated to Israel. Joe could form an offshore company (BVI or similar) to hold passive real-estate investments in other countries around the world, let Ephraim manage it and own 51 percent of its equity. Subject to checking in each country, it may be possible to enjoy a tax deferral in Joe's home country and an exemption in Israel for 10 years. However, NO Israeli exemption will normally apply to any income generated by Ephraim or the company from investments IN ISRAEL or activities performed IN ISRAEL. Comments on the new law • Publication: The new law enters into force formally upon publication in the Israeli government's gazette (reshumot). The above article is based on a final transcript of the new law and may be subject to slight changes when the law is published. • Immigration: It remains to be seen whether the new tax law will indeed attract immigration to Israel. The law requires the immigration absorption minister to report every year for three years to the Knesset Immigration Committee on the influence of the new law on the numbers of new residents and senior returning residents and on the number of people electing the one-year settling-in year for non-residents. • Old arrivers: People who arrived before January 1, 2007, will miss out entirely on the provisions of the new law; they will continue enjoying the provisions of the old law. • Returnees: Returning residents will suffer a longer waiting period abroad (five or six years instead of three years) to enjoy any Israeli tax benefits. • Pensions: After much controversy, it seems the new law will allow new residents and senior returning residents to enjoy the benefit of an existing section that limits the Israeli tax on foreign pensions (after the five- or 10-year exemption expires) to the amount of tax that would have been imposed abroad as a resident of the country where the pension is paid. However, the term "pension" remains undefined. (Does it include lump-sum distributions from a retirement account, such a US IRA, Canadian RSPP, UK SIPP or Australian "Super" fund?) • Activities in Israel: As mentioned, people who move to Israel and continue working IN ISRAEL for firms located abroad will be fully taxed in Israel on those earnings from day No. 1 in Israel. However, if they travel abroad to work part of the time, income earned on the days they are abroad will be exempt from Israeli tax (but check the foreign tax situation). • Patach deposits: New residents will continue to enjoy an exemption from Israeli tax for 20 years regarding interest on "Patach" foreign-currency time deposits of at least three months in Israel at an Israeli bank regulated in Israel. It is unclear whether returning residents will continue to enjoy a five-year exemption and whether senior returning residents will enjoy any exemption. • Trusts: The new law will apply to trusts settled by Israeli residents, including people who moved to Israel. Trustees and others having an interest in ANY trust with an Israeli connection or Israeli asset must start reporting to the Israel Tax Authority for all years up to 2007 by October 31, 2008. A low-tax amnesty is available for pre-2006 trusts and other special regulations are available if elected by that date. Specialist advice should be obtained in each potentially relevant case. 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.