Are you ready for the tax reforms?

As the new year approaches, English-speaking immigrants are turning to accountants and tax lawyers en masse to understand how the new tax reforms will affect their finances. After 20 months of negotiations, rumors, and regulatory flip-flopping on many minute- but extremely important – tax regulations, clueless as to what the new laws require. Many do not even know that they, like anyone with assets overseas, will be required to file a tax return next year. Are you ready for Israel’s most exhaustive tax overhaul ever?

Overview
The tax reforms, which were designed by a committee headed by former tax chief Yair Rabinovitch, are designed to lower the income-tax burden on working people by instead taxing capital gains on investments and other income sources. As such, investors will pay a 35 percent tax from capital gains on all foreign securities, and 15% on gains from Israeli stocks beginning in January 2004. Other assets, like real estate, are taxable at 25%.
For securities sold in 2003, the law offers a bit more leeway, noted advocate Ori Kalif, who works with tax expert Avi Alter in his Tel Aviv office. The tax on foreign stocks will be the lower of either 35% of the profit, or 5% of the value of the entire sale. Investors on TASE can pay either 15% of their capital gains, or 1% of the entire transaction value.

Everyone with any sort of income from abroad will be required to file a tax return in the coming year. This applies to people with assets above a certain minimum value, which will be in the range of NIS 36,000, CPA Don Shrensky stressed.

New immigrants are exempted from capital gains on securities purchased in their countries of origin within 10 years of aliya. New immigrants also have a five-year exemption on their pension funds, stock dividends, interest, royalties, and rent income. Foreign securities purchased after the date of aliya will be taxed as normal.

Further, immigrants who arrived in Israel between five and 10 years ago will pay no more than 15% on capital gains and interest from foreign securities, instead of the standard 35%. Immigrants fitting this description will also receive a tax exemption for 2003, Shrensky said.

According to a decision reached earlier this week by Income Tax Commissioner Tali Yaron-Eldar, investors can “virtually” sell their portfolios at the end of the year, and pay a 1% turnover tax. The decision should solve the current problem facing the TASE, as many investors have rushed to sell off their Israeli stocks before the higher tax rates kick in.

Under the terms of an agreement brokered last month by Minister-without-Portfolio Meir Sheetrit, the tax rate for capital gains on foreign securities will be lowered at the beginning of 2005 to 15%, the same as Israeli securities.
Many areas of the reforms are of particular interest to immigrants. Readers are encourages to consult their accountants and tax lawyers as their particular circumstances.

Foreign Pensions
Pension income from foreign countries will be exempted from taxes for five years from the pensioner’s date of aliya. After that date, pensions will be taxable at a rate no greater than the tax rate in the pension’s source country. Pensions will be generally exempt from tax in their source countries according to the double tax conventions that Israel has with most developed countries.
Approved Israeli pension funds have a 35% exemption for the first NIS 6,490 per month, and 35% of all overseas pensions funds have exemption, Kalif said. Shrensky explained that, following the 35% exemption, immigrants can choose to pay either the 15% rate on the remaining sum, or the total rate they would have paid in their country of origin. He added that the Income Tax Authority is considering changing that rule in the future to make it more fair to immigrants from all countries.

For people who have budgeted their retirement expenses around fixed-income investments under the previous system, under which pensions were not taxed, planning a new budget may be necessary.

It should be noted that this information is true only for pensions from private sources. Government pensions will be taxable only by the source country, as has been the case until now.

Investing
As mentioned, new immigrants will not be required to pay capital-gains tax on overseas securities within 10 years of aliya, although foreign securities bought after the date of immigration will be fully taxable at the 35% rate. Interest and dividends from these companies will also be taxable at 35% after the five-year immigrant exemption on them expires. Other assets, like real estate, have a 25% tax.

Immigrants who have been in Israel for less than 20 years and are more than 60 years old will pay 15% on foreign interest income, 25% on foreign dividends, and only 15% on capital gains, Kalif said.

Under the Income Tax Authority’s decision this week, investors can inform their banks or brokers of their intention to “virtually” sell and immediately repurchase their entire portfolio on December 31 and pay a 1% turnover tax, as if they had conducted the same transaction that specific date. The move will clean their slate with the Income Tax Authority for 2004, and their 2004 capital-gains tax payment will be based on their equity value for the beginning of 2004.
Banks have been charging a 0.5% turnover tax on Israeli stocks from the beginning of the year through June, and 1% from July to the end of 2003.

Under the reforms, mutual funds, which are traditionally considered safer investments than individual stocks, will now become more expensive from a tax perspective. Israeli mutual funds will now be available in two forms to give investors more options. “Taxable” funds will pay taxes on their trades internally, cutting into returns but exempting its investors from taxes on their returns. In “exempt” funds, investors will pay tax of 25% on their returns.
Capital losses from passive income from abroad will only be offset against passive income from abroad, while business losses from abroad will be offset against all income from abroad.
It is recommended that individuals follow up with an accountant or tax lawyer to find out how their portfolios will be affected.

Reporting
Almost every person holding assets located outside of Israel will be obligated to file a tax return in the coming year. People with less than a certain level of assets, to be set each year, will not be required to file.

Shrensky noted that it is not yet known how new immigrants will claim their exemptions. “Will there be a box to check to say that you are entitled to an exemption, or will you just not have to report your assets? This issue has not yet been decided,” he said.

US and Israeli income-tax authorities have exchanged information on the financial assets of US citizens living in Israel in an effort to cut down on money laundering, making it much harder for immigrants from the US to refrain from reporting overseas income and assets. The Finance Ministry has also set an April 2004 deadline for Israelis to divulge their overseas income, in order to combat money laundering. Once the April deadline has passed, the Income Tax Authority will consider every citizen with undeclared income – both passive and direct – as a tax evader, which is a criminal offense.

Calculating foreign currencies

The shekel value of passive income from dividends, interest on bank accounts, or rentals will be calculated according to the Bank of Israel’s representative shekel rate of the currency on the day the money enters the account abroad.

An appreciation of the value of the principal in a bank deposit as a result of differences in the exchange rate will not be taxed. However, principal appreciation in other investments that are not made in a bank will be subject to taxation.

Exchange rates on income from business transactions such as buying and selling goods, which are held in the interim as inventory, are calculated differently. Tax authorities will use both the date of purchase of the goods and the date of sale to determine the shekel-denominated income from the transaction.

Tax treaties
Israel has tax treaties with 39 countries, and all, except Canada’s, completely exempt pension funds from taxes in the source country, leaving Israel full authority to levy taxes. Most countries also give Israel the full rights to tax capital gains. What this means is that Israel, which was a tax haven for many before the reforms were approved, will now charge taxes at rates more in line with the rest of the Western World.

Ultimately, immigrants and returning citizens will be entitled to double tax exemptions on pensions for their first five years here, and get a 10-year reprieve from capital gains.
Canadian citizens are the only ones subject to double taxation, as their native country’s tax treaty allows it to charge 15% even on pensions received in Israel. This means that, once their immigration exemption period expires, they will be taxed another 15% here for a total of 30%.

Trusts
Tax expert Dr. Avi Alter noted that a separate set of legislation set to take affect within a few months will essentially abolish trusts as tools for tax planning. Once the trust reforms go into effect, trusts will become “tax traps”, Alter said. All incoming assets and money going into trusts will become taxable, although existing assets will not be touched.

Alter said all trust beneficiaries, including new immigrants, must report their arrangements to the tax authorities. He said trust settlers could be responsible to file for taxes if trustees do not.

Alter noted that a trust would not be taxable on foreign income if the settler is not based in Israel. He also recommended that trusts be transferred to a foreign corporation, which would give them more flexibility.