Israel is a small country dependent on exports and imports for much of its livelihood. So Israeli businesses often conduct business transactions in foreign (non-Israeli) currency. They must keep their books in new Israeli shekels for Israeli tax purposes.
If they are more than 25 percent foreign owned, there is an option to keep records in dollars in addition to (not instead of) shekels.
Israeli investors are free to invest any amount anywhere in the world, ever since exchange controls were abolished in 1998 on Israel's 50th Anniversary. Private investors need to report foreign-currency gains and losses in shekels on their Israeli tax returns.
On October 26, an Israel Tax Authority position paper clarified that trustees in Israel and abroad must report the income of certain trusts with an Israeli link in shekels. Until the end of 2009, year-end exchange rates may be used instead. Commencing January 1, 2010, such trustees must translate every trust transaction and balance into shekels according to Bank of Israel representative exchange rates.
The rules for translating business, investment and trust transactions from foreign currency to shekels are specified in regulations known as Income Tax Rules (Conversion to New Shekels of Amounts Originating Outside Israel), 2003.
What do these currency rules say?
Foreign business income and related expenses from business transactions must be translated into shekels at the Bank of Israel rate on the date the amount is accrued, derived or incurred, and on the date received or paid. Resulting exchange differences are treated as taxable income or a deductible expense (Income Tax Ordinance Section 2(4)).
This rule doesn't go far enough. In practice, businesses that apply the accrual basis (as opposed to the cash basis) typically revalue unpaid balances at the year-end, and resulting exchange differences are treated then as taxable income or a deductible expense. The same also applies to Israeli business income linked to foreign currency.
Income from dividends or rent is translated into shekels at the Bank of Israel rate on the date paid or received. Interest, exchange differences and related amounts invested are translated at the rate on: (1) the date of investment; (2) the year-end or realization date, whichever is earlier. If passive income is paid or received after the reporting year, use the rate at the year-end and on the date of payment.
The cost of the investment is translated at the Bank of Israel rate on the earlier date of acquisition or payment. The sale consideration is translated at the Bank of Israel rate on the earlier date of sale or receipt.
If paid during the year: at the Bank of Israel rate on the date paid. If paid within 24 months after the year-end: at the rate at the end of the year in which income is taxable in Israel. If paid after that: at the rate on the date paid.
Controlled foreign companies
Undistributed profits are translated into shekels at the Bank of Israel rate at the end of the period of assessment. Foreign professional company income
Income is translated into shekels at the Bank of Israel rate at the year-end.
Losses in shekels after applying the above rules are carried forward in shekels, not foreign currency.
Amounts paid or received in shekels are left in shekels.
Businesses in Israel by and large apply these rules. It remains to be seen whether and how trustees abroad will cope. In practice, the Bank of Israel publishes monthly and annual exchange rates for some currencies. If you feel it appropriate to use these, make reasonable disclosure in your tax-return filings.
As always, consult experienced tax advisors in each country at an early stage in specific cases.
Leon Harris is an international tax specialist at Harris Consulting & Tax Ltd., in association with Lion Orlitzky & Co. (Moore Stephens Israel).