What does the court's ruling on aliyah tax breaks mean for you? - opinion

This judgment will be of special interest to working olim and senior returning residents, who lived abroad at least 10 years, especially those in the hi-tech sector.

High Court of Justice prepares for hearing on whether Prime Minister Benjamin Netanyahu can form the next government, May 3, 2020 (photo credit: COURTESY HIGH COURT OF JUSTICE)
High Court of Justice prepares for hearing on whether Prime Minister Benjamin Netanyahu can form the next government, May 3, 2020
(photo credit: COURTESY HIGH COURT OF JUSTICE)
The Supreme Court ruled on the extent of the Israeli tax holiday that olim (new immigrants) are supposed to enjoy for 10 years regarding foreign income and gains (Yehuda Talmi v. Kfar Saba Assessing Officer, civil appeal 1779/18, December 2, 2020).
This judgment will be of special interest to working olim and senior returning residents, who lived abroad at least 10 years, especially those in the hi-tech sector.
Sometimes, the Israel Tax Authority can be a trifle reluctant to grant the tax holiday, especially if it means refunding excess tax withheld from the salaries of olim.
Background:
Section 14(a) of the Income Tax Ordinance says that a new resident or senior returning resident will be exempt from tax for 10 years on income from all sources listed in the tax law that was accrued or derived abroad or was derived from assets abroad... Section 97 provides a similar 10-year exemption for 10 years for foreign capital gains. Other sections override certain anti-avoidance rules and allow non-disclosure of income and assets abroad in that 10- year period.
The court noted that the tax holiday was enacted as Amendment 168 to the Income Tax Ordinance with effect from January 1, 2007, in order to bring quality personnel to the Israeli economy and to avoid unnecessary tax planning and friction with the tax authorities.
Facts of this case:
The taxpayer was a senior returning resident employed in Israel as regional sales manager by a UK company in a multinational group who returned to live in Israel in 2007, but traveled abroad on business trips.
The taxpayer turned down an offer of the ITA, based on tax circulars, to allow an exemption pro rata to the days worked abroad. This would have exempted them from tax on 9%-36% of total salary over the years 2007-2011.
Initially the taxpayer claimed to be exempt on 64% of his salary by increasing the weight given to time spent abroad. Then the taxpayer claimed he was 100% exempt because his salary was related to intangible ASSETS abroad he developed before his return to Israel, namely finance techniques and marketing models. The ITA found no mention of such intangible assets in his employment agreement. And the ITA visited his workplace in Israel and found all his work in Israel related to Israeli customers, not customers in other countries he claimed to service.
Later on, as the matter went to court, the taxpayer claimed that his employment agreement with the UK company itself represented a foreign asset, entitling him to 100% exemption on his salary from that company.
Issues in this case:
The main issue was whether the 100% exemption for income from foreign assets applies merely to investment income or also to income for work done?
Court ruling:
The Court said that Israel taxes income according to its source, similarly to the UK system of income schedules. The court ruled the taxpayer did not prove the salary was related to any assets abroad, only work. Moreover, the legislative intent of the tax holiday was to prevent migration to Israel triggering extra tax. In this case, the court assumed the UK would not tax salary earned in Israel by a resident.
Therefore, the court rejected the taxpayer’s appeal for 100% exemption – his salary related to work done mainly in Israel, not intangible assets abroad.
Comments:
The taxpayer failed to prove the facts in his case to the satisfaction of the court. But the court did clarify some significant principles for olim and returnees in their tax benefit period.
First, salary for days worked abroad may be exempted on a pro rata basis.
Second, passive income derived from assets abroad should generally be 100% exempt in Israel, such as passive dividends or interest income.
Third, the court said there may be instances where a person derives income from his employer which stems from intangible assets abroad, not work done, for example royalty income, in which case the asset-related (full) exemption may apply, even though the income is active not passive in nature.
Such exemption may conceivably apply to shares and share options granted to many hi-tech workers. The ITA’s stated policy is to deny the tax the tax holiday exemption to olim and returnees if they also qualify for a 25% tax rate under Israel’s ESOP (employee share ownership) rules. The ITA’s denial policy is controversial and it remains to be seen whether this judgment might change things.
As always, consult experienced tax advisers in each country at an early stage in specific cases.
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The writer is a certified public accountant and tax specialist at Harris Horowiz Consulting & Tax Ltd.