Financial Planning & Taxation in Israel and Overseas

By Leon Harris, international tax expert at Ernst & Young

See Also: Employment Resources

Following is a selection of frequently asked questions by potential Olim contemplating moving to live in Israel for the first time. Our remarks are short and general. As always, readers should obtain competent professional advice in each country concerned in specific cases.

Q: Should I sell my house outside Israel before I make Aliyah or afterwards?

A: From strictly a tax perspective, there is no pressure to sell your house prior to making Aliyah. As a new resident in Israel, the sale of the house you owned prior to becoming an Israeli resident will be exempt from Israeli capital gains tax for 10 years after you have become an Israeli resident. If the house is sold after 10 years, a pro-rata exemption will apply to the gain according to a special formula based on your period of ownership. The proportion ending 10 years after arrival is exempted.

You should also consider the taxes that may be applicable in the country where the house is located.

As far as purchasing a home in Israel, there is no particular rush. The beneficial rate of acquisition tax of 0.5% (up to a monetary limit, instead of up to 5%) applies to new “olim”, from one year prior to their arrival to seven years after becoming a new “oleh”.

Q: What financial planning is advisable for passive income?

There are various Israeli tax exemptions for new residents that relate to the income or gains of assets held before arriving in Israel as residents. Sometimes it is beneficial to implement tax planning before arrival in Israel, especially with regards to the following:

• Foreign investments
• Securities and real estate
• Israeli investments, especially securities

In practice a mixture of trusts, companies, long term investment instruments, and PATACH foreign currency accounts at Israeli banks are usually considered depending on family circumstances and needs. You should also consult licensed financial advisors regarding the selection of investments.

Q: What are the tax implications/issues of a commuter?

A: We assume you are referring to a case in which a family arrives in Israel, and a spouse flies back regularly to the “old” country for business reasons. It will first be necessary to ascertain the residency of the commuter and his/her spouse. The date they became Israeli residents is essential in figuring out when their new resident exemptions begin and end. 

Additionally, a commuter may be considered resident in more than one country. If so, it will be necessary to refer to the tie breaker tests in the applicable double tax treaty.

There are a number of Israeli tax benefits granted to new residents for limited period after becoming Israeli residents. For instance, an exemption from “business” income may be granted for the first 4 years after becoming an Israeli resident, on income from a business that the taxpayer had abroad for at least 5 years prior to first becoming an Israeli resident. Therefore, it may sometimes be possible for a commuter who owns a business abroad to request an exemption for “business” income for up to 4 years if that person conducted a similar business prior to becoming an Israeli resident.

As regards to specific rules that apply to commuters, it should be noted that different tax regimes apply in Israel depending on whether the individual is (1) an Israeli resident employed abroad for over 4 continuous months by an Israeli employer (2) an Israeli resident working abroad in other circumstances (foreign employer, self employed etc.) (3) non-Israeli resident individual.  See Annex A for details.

Q: Is it advisable from a tax perspective to work a certain number of days abroad?

A: Effective January 1, 2003, an Israeli tax reform law clarified the definition of residency for tax purposes, subject to any applicable tax treaty. Individuals will be resident if their center of living is in Israel, having regard to their overall personal, family economic and social circumstances. Individuals will generally be presumed resident if they are present in Israel 183 days or more in a tax year, or 30 days in a tax year and 425 days in Israel in a particular year plus the previous two years. Therefore in practice someone may be resident if he or she is present in Israel over 141 days a year (for three consecutive years). A day includes a part of a day. These presumptions are refutable by the taxpayer or the tax authorities.

If an individual does not want to be considered resident in Israel and consequently subject to worldwide tax in Israel, he should avoid being present in Israel 141 days a year. However, as mentioned above the number of days test is refutable by the ITA. Therefore, even if someone is in Israel less than 183 days in a tax year, or 30 days in a tax year and 425 days in a particular year plus the previous two years, the ITA could claim that their center of living is in Israel and therefore they are actually resident in Israel.

Q: What are the tax implications of a telecommuter?

A:  We assume you are referring to someone who works on their computer in Israel for a non-Israeli resident employer. Anyone who is resident and works in Israel – on their computer or otherwise -  will be taxable in Israel on their worldwide income. And the employer should check whether the employer is doing business in Israel via that individual – if so, the employer may also be liable to Israeli income tax (and VAT) on their Israeli source business income.

Q: How are pensions and social security payouts to Olim taxed?

In the First Five Years:  pensions from abroad, should be exempt from Israeli tax for the first five years after becoming a new Israeli resident.  However they may be liable to tax in the source country – in will be necessary to refer to the relevant tax treaty.

After First Five Years: Once again, it will be necessary to check the relevant tax treaty. Generally, non Israeli pensions will be taxable in Israeli if that is where the individual recipient is resident. According to the US-Israeli treaty, US pension will only be taxable in Israel, except for governmental pensions which are only taxable in the US. According to the Canada Israel treaty, if one receives their pension from Canada, it may be taxed where the individual is resident i.e. Israel. Additionally, there is a 15% maximum rate of Canadian withholding tax on periodic pension payments originating from Canada and paid to an Israeli resident. There are exceptions where a 25% Canadian withholding tax may apply.

Subject to any tax treaty, Israel generally does not tax income when derived by a bona fide pension fund, however subsequent distributions therefrom are taxable. Such distributions may be considered earned income, as this generally includes a pension paid by a former employer, a pension paid by a provident or pension fund in respect of employment, and a lump sum received upon retirement etc.  Such income is subject to tax at standard Israeli individual tax rates of up to 49% (48% in 2007).

According to special rules, the Israeli tax on a pension received by an immigrant to Israel (“oleh”), whose source is outside of Israel and is paid for work outside of Israel, will not exceed the tax that would have been payable in the country where it is paid if he remained a resident of that country. For example, for an ex-US resident, the tax rate will be capped at the amount of tax that would apply in the US on such a pension. It seems this benefit generally only applies to new immigrants, and not returning residents.

Alternatively, if the taxpayer has reached retirement age (generally 64 for a women and 67 for a man), 35% of their pension/annuity will become exempt from tax, leaving 65% taxable at regular Israeli tax rates of up to 49% (48% in 2007) resulting in an effective Israeli tax rate of up to 31.85% (31.2% in 2007).

The taxpayer may choose each year between the available alternatives.

Q: What about US Individual Retirement Accounts (IRA) and Canadian Registered Retirement Savings Plan (RRSP)?

A:  According to senior officials at the Israeli tax authority, an IRA or an RRSP may be treated as a pension for Israeli tax purposes if the payouts are predetermined. However, if the beneficiary can vary the payouts, the IRA or RRSP will be subject to Israeli tax as if it were a mutual fund.

If the plan is treated as a pension fund, the pension distributions will be exempt from Israeli tax for the first five years. Afterwards one can choose to between paying the amount of tax applicable in the old country of residence or the 35% exemption if over retirement age, as explained above.

If the plan is treated as a mutual fund, the income element (but not the capital) will be taxed in Israel at a rate of 20%, after the expiry of the five year exemption period.

Q: What about social security pension payouts?

A:  Generally social security payments paid by another country will be taxable in Israel. The US-Israeli treaty exempts social security payments from being taxed by both countries.

Q:  What are the tax ramifications of an inheritance from the US?

A:  The US-Israel does not deal with the US taxes on gifts and estates. If not planned well, an inheritance from the US left to an Israeli resident can be subject to double taxation.  The assets of the US resident relative donor may be subject to US estate tax of up to 46% (2006 rate) upon their death and may be subject to Israeli capital gains tax upon a subsequent sale by the Israeli resident recipient. 

There is no provision in the Israeli tax law allowing a credit for US estate tax paid against Israeli capital gains tax upon a subsequent sale of up to 49% in certain cases.  Also there is no provision that would “step up” the cost basis of the assets to market value for Israeli tax purposes – the recipient assumes the donor’s cost basis.  Israeli capital gains tax, which ranges from 20% to 49%, will apply on the capital gain arising from the sale of the assets. The result may be combined taxes at a total of up to 95%.

In addition, the capital gain will be calculated for Israeli tax purposes in new Israeli shekels and adjusted for inflation according to the Israeli consumer price index. Only the post 1993 inflationary gain is exempt - an additional 10% tax will be imposed on the pre-1994 inflationary gain.

In many cases there is no intention to sell the principal assets concerned – often the family home and perhaps securities.

Therefore, if the donor settles a lifetime or testamentary trust for the benefit of an Israeli resident, that may help avoid double taxation, assuming certain conditions are met and the trust is considered a tax privileged Foreign Resident Settlor Trust (FRST) for Israeli tax purposes.

Alternatively one may consider a lifetime sale which would apparently trigger US capital gains tax of 15% presumably and a cost “step up” for Israeli tax purposes to fair market value thereby reducing the double tax exposure.

Another alternative is to request relief in a tax ruling from the Israeli Tax Authority. Such relief may sometimes take the form of a revaluation to market value of inherited assets for foreign estate/inheritance tax purposes upon the death of the donor.

If the intention is to transfer the future ownership by Will to the benefit of the children, it may be prudent for you to consider a trust or testamentary trust.

Q:  Is it advisable for certain individuals to declare Aliyah as opposed to staying on resident status?

A: Generally, from a tax perspective it is irrelevant whether one makes aliyah, rather what is important is whether an individual is resident in Israel.

However in borderline cases where an individual may be viewed as resident of two countries (according to the domestic law of both countries), it will be necessary to refer to the “tiebreaker” tests in the relevant double tax treaty. In certain treaties, such as Israel's tax treaties with the US and South Africa, there are provisions stating that in the case of a person who is an “oleh”, his center of vital interests (and residency) shall be deemed to be in Israel.

On the other hand, certain tax benefits related to purchasing real estate such as a reduced rate of acquisition tax (0.5% up to a monetary limit) may be dependent on an individual being an “oleh”.

Annex A: Israeli Residents Working Abroad

Contrary to popular belief, if an Israeli resident is assigned to work abroad, that individual does not automatically drop out the Israeli tax net. They will generally be taxable where they work and taxable in Israel if they remain Israeli residents – but Israel may allow various deductions and a foreign tax credit.
This article reviews some of the Israeli tax rules for Israeli residents who relocate abroad.

Who is taxable in Israel? Resident individuals are subject to tax on their worldwide income and worldwide capital gains. 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. This can apply even if they are present in Israel less than 183 days in a tax year (or 425 days over 3 years).

Rules for Israelis working abroad?  Different tax regimes apply in Israel depending on whether the individual is (1) an Israeli resident employed abroad for more than four continuous months by an Israeli employer (2) an Israeli resident working abroad in other circumstances (foreign employer, self employed etc.) (3) non-Israeli resident individual.

Working abroad - Israeli resident employer: Under this scenario, Israeli residents who work abroad for an Israeli resident employer for a continuous period of more than four months are taxed in Israel at special rates on taxable employment income and benefits.  These rates which are expressed in US dollars rather than Shekels.

This scenario is likely to apply if an Israeli company employs the individual abroad for more than four months. If the individual returns to Israel on weekends it is unclear whether his stay abroad will be considered a “continuous” four month period, however assuming he returns to Israel for less than two weeks at a time,  it appears that the continuity will not be considered to be broken.

The current Israeli tax rates (in US dollars) for such persons are as follows:

• 20% on monthly income of $0 - $1,100
• 30% on monthly income of $1,101 - $2,200
• 40% on monthly income of $2,201 - $3,300
• 45% on monthly income of $3,301 - $4,400
• 48% on monthly income over $4,400.

Deductions for Israeli tax purposes in such cases are as follows:
Personal deductions are granted in lieu of the regular system of "credit points" for Israeli residents as follows:

• 50% of base salary for monthly income of $0 - $2,000
• 45% of base salary for monthly income of $2,001- $6,000
• 50% of base salary for monthly income over $6,000

The base salary for these purposes is prescribed according to location, for example $3,640 in the USA and GBP 2,768 in the UK.

• Tax deduction for travel costs at the start and completion of the overseas assignment for the assignee, spouse and children under 19 and home leave travel once every two years of the assignment.
• Housing allowance up to a prescribed amount. The monthly housing allowance is limited in New York to $5,200 ($5000 in Manhattan), $ 4,200 per in London and $3,000 in the rest of the UK. However, details and proof of rental income received from rental of the employees’ private Israeli residence must be presented by the company to the Israeli tax authorities - this is to ensure that private rental income is taxed unless it is below the taxable limit.
• Allowable medical expenses for the assignee, spouse and children under 19, up to the same service level normally given in Israel.
• Allowable meal expenses up to $35 per day for business travel from the assigned country to another overseas country (excluding Israel). ($8 Breakfast, $15 Lunch, $12 Dinner).
• Education allowance - Limited to $ 450 per month for each child below 19 throughout the year. The Israeli Tax Authority (“ITA”) may allow a higher deduction (typically 25% more) having regard to the location and educational conditions.

Working Abroad – Non-Israeli Resident Employer

Under this scenario, Israeli residents working abroad as self-employed persons or for non-Israeli resident employers or for Israeli resident employers for a period of less than four months, are taxed at the regular Israeli tax rates on taxable employment income and benefits.

The following table presents the regular 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

Deductions for Israeli tax purposes in such cases are as follows:

• Airplane tickets purchased for business purposes, but no more than business class rates.
• Daily lodging allowance, dependent on the period spent abroad. For the first 7 days, the daily lodging allowance may not exceed $222. For a period of 8-90 days, 75% of the expenses which are between $98 and $166 are deductible. For a period over 90 days, and starting from the first day, the daily deductible expense may not exceed $ 98. Proof of expenses is necessary. e.g.: Rental Agreement.
• In addition to the above daily lodging allowance, a per diem allowance of $ 62 is deductible. Proof of expenses is not required.
• If the above two allowances are not utilized, a flat rate allowance of $ 104 per day is available. Proof of expenses is not required.
• An additional allowance of up to $ 49 per day is allowable for car expenses including car rental, car taxes, fuel and insurance etc.  Proof of expenses is necessary.
• Education allowance - If stay is over 10 months. Limited to $ 557 per month for each child below 18. The ITA may allow a higher deduction having regard to the location and educational conditions.

In various countries, the deductions for lodging and per diem expenses may be increased by 25% of the above-mentioned amounts. These countries include the following: Hong Kong, Korea, Italy, Angola, Germany, Netherlands, Norway, Finland, Cameroon, Switzerland, Taiwan, Australia, Iceland, Belgium, Dubai, Greece, Spain, France, Canada, Japan, Austria, Ireland, Denmark, Luxembourg, Oman, Qatar, Sweden and the UK.

Non-Israeli Resident Working Abroad:  In the case of a non-Israeli resident working outside of Israel, no Israeli tax liability should arise on such employment income. Consequently, expenses will not be deductible in Israel.

Exit Taxation:  Persons who cease to be Israeli residents are generally liable to capital gains tax at rates of 20% - 49% as if they sold all their assets one day before they ceased to be residents. This especially applies to employee stock option and purchase arrangements. The tax is payable upon departure or upon the sale of the relevant assets. An exemption applies if the tax will be due later in Israel upon realization, for example regarding Israeli real estate (if the residential home exemption is not applicable).

Foreign tax credits:  Israel generally allows a credit for foreign federal and state taxes on foreign source income, but not city taxes. Detailed rules apply in this regard.

National insurance (social security):  Israeli residents are entitled to Israeli social security benefits. For the first five years, the Israeli National Insurance Institute tend to apply a wait-and-see attitude to the question of an individual's residency status. This means that even after 5 years, the National Insurance Institute could review the facts and conclude that residency and social security benefits were terminated upon departure from Israel, especially if no National Insurance contributions were paid after departure. Subject to any social security totalization agreement, if an individual remains Israeli resident and employed by an Israeli resident employer, regular Israeli national insurance rates are generally collected. If an Israeli resident is employed abroad by a foreign resident, they may in practice apply to the National Insurance Institute to pay a more limited national insurance contribution of NIS 137 per month (currently) and receive correspondingly limited Israeli social security benefits. In practice, it is recommended that comprehensive private medical cover be arranged for Israelis working abroad and their families. Other detailed rules exist.

Exchange control: None in Israel.

To sum up, Israelis working abroad perform a valuable role, but may remain taxable in Israel. It is advisable to obtain upfront professional advice in Israel and the other country concerned.

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