Your Taxes: Israel's bailout plan

One of the proposed measures is tax legislation to stimulate the inflow of capital into Israel and investment in the capital market.

taxes good 88 (photo credit: )
taxes good 88
(photo credit: )
On November 25, the Finance Ministry announced a series of measures for dealing with "market failures" and for expanding the credit supply following the international financial crisis. Israel doesn't seem to be in too bad shape at present, but America just sneezed, so we must be next. One of the proposed measures is tax legislation to stimulate the inflow of capital into Israel and investment in the capital market. The other measures include: state guarantees totaling NIS 6 billion for the banks to expand credit; NIS 5b. to establish investment funds that will co-invest with pension funds in corporate bonds; and "credit officers" to assist with corporate-bond recycling. The objective of these measures is to relieve credit shortages, strengthen the Israeli capital markets and augment the previous week's plan for accelerating public works. And don't forget the safety-net plans to combat recent pension-fund losses. Nearly every politician has a plan. Proposed tax measures • First, the Israeli tax rate would drop from 25 percent to 5% for dividends distributed in 2009 by foreign companies held by Israeli companies. The aim is to encourage monies to be repatriated to the Israeli economy. This echoes the American Jobs Creation Act of 2004, which offered American multinationals a 5.25% tax rate if they repatriated their overseas earnings and reinvested them in their business; so they did, but apparently this didn't increase employment and wasn't intended to deal with any credit crunch. • Second, foreign residents would enjoy an exemption from Israeli tax on interest on corporate bonds traded on the Tel Aviv Stock Exchange. This would complement an existing capital-gains tax exemption for foreign investors in Israeli publicly traded securities. It would also complement an exemption for interest in "Patach" foreign-currency deposits at Israeli banks. The US already offers a similar portfolio-interest exemption for non-US interest recipients. What the Finance Ministry apparently didn't propose is an exemption for foreign residents who invest in shekel deposits at an Israeli bank. • Third, a broad simple exemption would be granted "unconditionally" to foreign-resident investors who derive capital gains from Israeli securities. But two conditions are proposed! The exemption would not apply to: (1) gains from securities in companies whose main assets are Israeli real-estate interests; (2) gains attributable to an Israeli "permanent establishment" (usually a fixed place of business or branch) of the foreign investor. This proposed exemption would supersede an existing capital-gains tax exemption (which expires at the end of 2008) for foreign investors in Israeli securities if they have resided at least 10 years in a country that has a tax treaty with Israel and they notify the Israel Tax Authority of their investment within 30 days after acquiring the securities. Will these proposals work? Perhaps. Do we want the proposals to work? Depends. If they work, more capital may flow into Israel and drive up the exchange rate. Currently the Bank of Israel is trying to devalue the shekel. For example, suppose an Israeli hi-tech firm makes $1 million in sales in the United States. At current exchange rates, that means nearly NIS 4m. to pay Israeli salaries. The main expense in hi-tech firms is usually salaries. But if capital flows into Israel and the shekel strengthens to NIS 3 per $1, then $1m. of sales translates into only NIS 3m. to pay Israeli salaries. Potential result: unemployment? What's next? We await enactment of the proposals, presumably after the general election next February and subsequent formation of a new coalition government. Leon Harris is an international tax specialist.