Your Tax in '06: Special investment rules

Are foreign investors taxed in Israel? Generally, yes on dividends, interest, capital gains and so forth. Nevertheless, the picture is improving.

taxes 2 88 (photo credit: )
taxes 2 88
(photo credit: )
Are foreign investors taxed in Israel? Generally, yes on dividends, interest, capital gains and so forth. Nevertheless, the picture is improving. Foreign investors may enjoy an exemption from Israeli capital gains if they invest in Israeli publicly traded securities or R&D intensive companies. They also may be exempt on a sale of any Israeli securities (unless real estate-related) acquired from July 1, 2005 to December 31, 2008 if they resided in a tax treaty country for 10 years and notify the Israeli Tax Authority within 30 days after acquiring their investment. Some tax treaties also offer capital gains tax exemption in Israel in certain cases. This exemption continues to apply if the investor moves to Israel and takes up residence here. What else applies to new residents? A tax exemption is granted to new residents for the first 10 years after becoming an Israeli resident for capital gains derived from overseas assets held upon becoming a resident. If such an asset is sold after 10 years, a pro-rata exemption will apply according to a special formula. Additionally, a new resident's exemption for passive (non-business) income from dividends, interest, rent, royalties or pensions is granted for the first five years after becoming an Israeli resident, if such income is of a non-business nature and derived from overseas assets held upon becoming a resident. The above exemptions are also available to returning Israeli residents who resided abroad for more than three years. If no exemption applies, beneficial Israeli tax rates nevertheless could be applied to the income from publicly traded foreign securities of someone who was a "privileged individual" in the tax years 2003-2005 only if they became Israeli residents within the last 10 to 20 days: interest and capital gains - 15%, dividends - 25%. What about double tax relief? In the event that tax is imposed abroad, Israel will generally allow a credit for foreign federal and state taxes against Israeli tax on the income from the same source ("basket"). Foreign city taxes cannot be credited. Some foreign countries do not tax investment income in certain cases. For example, the UK does not tax non-UK residents on UK source capital gains. The US generally does not tax non-US investors on interest income and capital gains (except from US real estate) if certain conditions are met. Dividends paid by US corporations to Israeli residents will generally be subject to withholding tax taxable at rate of 25% under the US-Israel tax treaty (or 12.5% for Israeli 10%-or-more corporate shareholders). The non-treaty rate of withholding tax in the US is 30% for dividends, interest, rent, royalties and certain other types of income. (There are limited instances in which a US corporation can make dividend, interest and other payments to non-US persons free of withholding tax - these generally would be achieved through specific planning). The aforementioned conditions in the US include the filing of declarations of non-US status, usually on Form W8-BEN. Israeli residents holding US citizenship, residency or "green card" status will be taxable in the US. and Israel, but special foreign tax credit provisions may apply to them under the US-Israel tax treaty. How are seasoned professional investors taxed? People who deal regularly in securities will be taxable at full rates (companies 31% in 2006, individuals up to 49% plus national insurance liability - see above). This could conceivably include anyone conducting frequent securities transactions rather than occasional transactions for investment purposes. The dividing line is not clear in practice, but the Israeli tax authority has indicated that no more than a "few tens" (20-30 apparently) of securities transactions a month may not be regarded as trading. In practice, the Israeli tax authority rarely catches Internet day traders and others unless it is clear that they do so actively with a view to making a living from such activities. But if you personally dabble in more than a few dozen derivatives transactions per month, the Israeli tax authorities have indicated you may have enough professional knowledge to be considered a securities dealer. If you invest in US securities from Israel on your own account in the US you should not be taxable in the US unless you are a U.S. person (US citizen, green card holder or US resident - see above). However, if you are a non-US person there may be US withholding tax on dividends and certain types of interest; and US real estate interests or securities will be taxable in the US under the Foreign Investment in Real Property Act (FIRPTA). Are finance expenses recognized? In principle, if you use leverage - borrow money to invest in securities - interest paid should be deductible as an expense in Israel against income from the investments concerned. However, if you borrow money from a non-Israeli resident (e.g., a bank or broker in New York or London), you are expected to withhold Israeli tax at source from the interest - generally up to 25% but reduced to 17.5% for a US lender and 15% for a UK lender under Israel's tax treaties with those countries - otherwise, no expense deduction is permissible and you may face possible penalties for failure to withhold. In practice, enforcement in this area tends to be weak. Furthermore, if you leverage your investments, the Israeli tax authorities may use this to assert you are a securities dealer taxable at full rates. How can losses be used? Investment losses are governed by detailed rules. Capital losses derived by individuals in 2006 onwards from foreign securities may be offset against capital gains from Israeli securities (and vice versa) or against dividends and interest income from securities (if otherwise taxable at no more than 25%). However, pre-2006 losses from foreign securities may not be offset against gains from Israeli securities (and vice versa) before 2007. The writer is an International Tax Partner at Ernst & Young Israel (With thanks to Ed Rieu of the Ernst & Young US Desk, London)