Working in Israel: Understanding the local tax system

Immigrants are usually classified as residents for Israeli tax purposes. However, there are benefits.

taxes 2 88 (photo credit: )
taxes 2 88
(photo credit: )
This article summarizes Israeli tax aspects that may be relevant to individuals who live and work in Israel or relocate to the country on a work assignment. Assignees quickly find out that Israel has its own independent tax system. Therefore, they hopefully will receive an exit interview in their country of departure and an arrival interview in Israel with tax and other advisers to review these aspects in detail. In addition, an Israeli labor law specialist should be consulted regarding any employment agreement and other employment matters. The aim is to understand in general terms how the Israeli tax system works and check that no double taxation will arise in the case of assignees or citizens of another country. Who is taxable in Israel? Resident individuals are subject to tax on their worldwide income and worldwide capital gains. Non-resident individuals are subject to tax on income from Israeli sources, which is income accrued or derived in Israel. However, there's a pleasant surprise. Some tax treaties exempt employees resident in the country concerned from Israeli tax. Usually the treaty exemption is conditional on the employee being present under 183 days in Israel in the tax year and employed by a non-Israeli resident employer who does not charge the individual's remuneration to a "permanent establishment" (fixed place of business) in Israel. An Israeli resident individual is defined as a person whose center of living is in Israel, taking into account the person's family, economic and social links Under the law, a rebuttable presumption of Israeli residency will apply if either the individual is present in Israel at least 183 days in a tax year ending December 31 or the individual is present in Israel at least 30 days in the current tax year and a cumulative of 425 days in the current and two preceding tax years. New immigrants are generally classified as residents for Israeli tax purposes. However, they may enjoy certain income tax, capital gains tax and import tax benefits for specified periods. Special rules apply to diplomats, consuls, priests, soldiers, sportsmen etc. What about fringe benefits? Taxable employment income broadly covers salary and virtually all cash and in-kind benefits and allowances provided directly or indirectly to employees or for their benefit. If benefits are provided on a net-of-tax basis, they must be grossed up for tax purposes. A company automobile placed at an employee's disposal is taxable based on its prescribed usage value in tables published by the Tax Authority. The usage value depends on the price group of the model shown on the vehicle registration. Also taxable are benefits such as the use of a cell phone provided by the employer, children's schooling, housing benefits provided and so forth. If no treaty exemption applies, expatriate non-residents working in Israel lawfully for an employer may enjoy certain Israeli tax benefits. For the first 12 months in Israel, a foreign expert is entitled to a deduction for accommodation expenses incurred and a living expense deduction of up to NIS 270 per day if his employment income exceeds NIS 11,000 per month. Foreign journalists who are members of the Foreign Press Association in Israel and foreign sportsmen are entitled to a tax rate of 25% and the above-mentioned expatriate deductions for the first 36 months of work in Israel for foreign journalists and 48 months for foreign sportsmen. A maximum tax rate of 25% for up to three years (extendible for up to five more years) applies to an expatriate if an Israeli resident invites the expatriate to work in Israel and applies to the Investment Center for approved specialist status for the expatriate before his or her arrival. This status is granted on a limited discretionary basis primarily to industrial or tourism specialists. If granted, the reduced tax rate usually applies only to the first US$75,000 of annual salary. On the other hand, a levy at the rate of 10% is levied on foreign employees' employment income unless they are journalists or sportsmen or if the employment income exceeds NIS 14,766 per month. The levy must be paid by the employer and is not deducted from the employment income. Proposals exist to raise the levy to 18% in 2007. What about retirement and savings plans? Some Israeli employers provide a range of social benefits through external government-approved provident. The funds are administered by Israeli banks, insurance companies or other financial institutions. The social benefits provided typically include some or all of the following up to various monetary limits specified in the tax law: * Retirement plans - employee pays 7% of salary, employer pays 7.5%. The employee may enjoy a 35% tax credit in the case of a comprehensive pension plan and a 25% tax credit in the case of long term savings plan. Employer contributions into these plans are not taxed. The monthly salary limit for these tax benefits is currently NIS 7,300. * Severance pay funding - employer pays 8.33% to special fund at a financial institution. * Further education savings plans - employer typically pays 2.5%, employer pays 2.5%; after six years the money may be withdrawn and used for any purpose. The monthly salary limit for these tax benefits is currently NIS 15,712. * Disability insurance - employer pays 2.5%. Stock Option Plans: Detailed rules in Section 102 of the Income Tax Ordinance apply to employee share option plans and share purchase plans. Capital gains tax treatment is permissible for certain qualified plans called Section 102 plans, which are administered by a trustee. Employers may chose between alternative rules for allocating gains between salary income (the employer deducts an option expense but the employee is subject to income tax at regular rates of up to 49% (48% in 2007) plus national insurance contributions) and capital gains (the employer receives no deduction and the employee is subject to capital gains tax at a rate of 25%). For options granted on or after January 1, 2006, to obtain the capital gains tax treatment, the options must be held for at least two years after their grant date. For salary treatment the minimum holding period is one year. The tax authorities must approve the trustee and receive notice concerning a Section 102 plan at least 30 days before the implementation of the plan. Individuals who move to another country to work or reside may request tax rulings from the tax authorities to mitigate uncertainty or address double taxation. Income Tax Rates: The Israeli tax year is the calendar year. In principle, Israeli personal tax liability is computed annually although tax is typically withheld from salaries and reported each month. Monthly tax brackets used during a year for payroll and other purposes are updated annually for inflation and are totaled to produce the annual tax brackets. The following table presents the monthly taxable income brackets for 2006. * 10% on monthly taxable income of NIS 0 - NIS 4,280 * 22% on monthly taxable income of NIS 4,281 - NIS 7,620 * 29% on monthly taxable income of NIS 7,621 - NIS 11,440 * 36% on monthly taxable income of NIS 11,441 - NIS 20,420 * 37% on monthly taxable income of NIS 20,421 - NIS 35,370 * 49% on monthly taxable income of NIS 35,371 or more The rates below 30% are restricted to income earned from employment and self-employment and to rental income derived by persons over 60 years of age. In other cases, a minimum tax rate of 30% applies. National Insurance (Social Security) Rates: National insurance contributions are generally payable on taxable income as calculated for income tax purposes. The following table sets out the rates of national insurance contributions. For residents, these rates include a supplementary health levy. Foreign residents generally arrange comprehensive private health care. On monthly income of NIS 0 - 4,430: * Employer: 4.98% for resident employees, 0.72% for nonresident employee * Employee: 3.5% for resident employees, 0.04% for nonresident employees * Self Employed: 9.82% for residents, 0.56% for nonresidents * Passive income: 9.61% for residents On monthly income of NIS 4,431 - 35,760 (upper limit): * Employer: 5.68% for resident employees, 0.80% for nonresident employees * Employee: 12% for resident employees, 0.87% for nonresident employees * Self Employed: 16.23% for residents, 0.82% for nonresidents * Passive income: 16.05% for residents Fifty-two percent of national insurance contributions paid in a tax year on nonemployment income is deductible for income tax purposes in that year. Lower contributions apply to Israeli residents who work abroad as self-employed persons for continuous periods exceeding six months or for nonresident employers unless they were hired in Israel. The above is subject to social security totalization agreements Israel has with certain other countries (not the US). Exit Taxation: Persons who cease to be Israeli residents are generally liable for capital gains tax at rates of 20%-49% as if they sold all their assets one day before they ceased to be residents. The tax is payable upon departure or upon the sale of the relevant assets. Deductions and credits allowed: Business-related expenses incurred by employees are deductible only in limited circumstances. For example, expenses incurred to update existing professional knowledge are deductible. However, to claim these deductions, employees generally must file annual personal Israeli tax returns even if they are otherwise exempt from filing. In general, tax relief for individuals is in the form of tax credits rather than tax deductions. Israeli resident individuals are entitled to personal tax credits, which are known as credit points. These credit points are deducted from the computed income tax liability of individuals. Each credit point is currently worth NIS 178 per month. The number of credit points granted to an individual reflects family circumstances. For example, an unmarried male resident generally receives 2.25 credit points and an unmarried female resident generally receives 2.75 credit points. If both spouses work and opt for separate tax computations, the husband receives 2.25 credit points and the wife receives 2.75 points; the wife also generally receives one credit point for each child under 18 years of age and one-half of a credit point for a child born or reaching 18 in the tax year. The following are other significant tax credits granted to resident individuals: * Tax credit for 35% of charitable contributions to recognized institutions if a taxpayer's annual contributions exceed NIS 370. However, no credit is given for annual contributions exceeding 30% of taxable income or NIS 2,165,000, whichever is lower. * A 25% tax credit for life insurance contributions to the extent that pension and long-term savings policy tax limits are not fully utilized. * Additional credits in various other cases, including new immigrants, one-parent families, divorcees, graduates of a high education institute and residents living and working in various priority areas. Tax reporting: Due to the monthly withholding tax system, annual personal tax returns are not always required from employees who earn less than a specified amount. Estate and gifts tax? Generally none, but gifts of assets (not cash) to a foreign resident are subject to capital gains tax - so think before giving shares or real estate to your brother in New York or London - there is no Israeli tax if you bequeath him those assets upon your death in your will. To sum up, we work to keep our families and our system of law and order sustained but it is as well to understand who gets what. As always, consult tax advisors in each country in specific cases. The writer is an International Tax Partner at Ernst & Young Israel