We wish to bring to your attention some of the significant changes in the Israeli tax legislation, as part of recent legislative amendments which are related to the state budget for 2013-2014 (“the Budget Legislation”). The changes will enter into force as of January 1st, 2014 (unless otherwise stated).
Within the Budget Legislation, the Income Tax Ordinance (“ITO”) and the Real Estate Taxation Law (“RETL”) were amended. The changes are set forth below in summary format:
1. Increase of tax rates:
1.1 Increase of the corporate tax rate by 1.5%, from 25% to 26.5%.
1.2 For individuals, the tax rate in each bracket will increase by 2%. This means that the tax brackets for active incomes will range from 11% to 50% and for passive incomes, from 32.4% to 50%. In addition it shall be noted that according to a legislative change that passed a few months ago, from 2013 a “surcharge” at a rate of 2% applies to an annual income in excess of NIS 811,000(approximately $225,000), with some exceptions.
2. Trusts:
Within the amendment to the Trusts Chapter in the ITO, the following amendments were adopted (generally, the new provisions will apply as from 2014, with some exceptions):
2.1 Today, as a rule, a foreign-resident settlor trust (that is a trust in which all settlors are non-Israeli-residents, irrespective of the identity of the trustee or beneficiaries), is considered to be a foreign resident for tax purposes (and therefore is exempt from taxes on income that was generated outside of Israel and also from certain income that was generated in Israel). The definition of a
“foreign-resident settlor trust” was amended to a “foreign-residents trust”, and it will be considered as such only if all of the settlors and beneficiaries thereof are foreign residents, i.e. it will no longer include Israeli beneficiaries.
2.2 Further to the foregoing, a definition of a new type of trust was added to the Trusts Chapter in the ITO – an “Israeli resident beneficiary trust”, which is a trust whose settlors are foreign residents and that has at least one beneficiary who is an Israeli resident. One of the types of an “Israeli resident beneficiary trust” is a “relatives trust” in which the Israeli settlors and beneficiaries have certain degree of family relationship.
An “Israeli resident beneficiary trust” that is not a “relatives trust”, will be considered to be an Israeli individual and therefore its income will be taxed as such.
Two alternatives for the taxation of a relatives trust’s foreign source income have been set: in one alternative, 30% tax is imposed at the time of distribution to the Israeli beneficiary (with some exceptions). Pursuant to the second alternative, which is subject to immediate notification of the trustee (for selecting this alternative), 25% tax will be imposed on the part that is expected to be distributed to the Israeli beneficiary (sometime in the future), in the year in which the income was generated by the trust, whether distributed or not.
2.3 An “Israeli residents trust” will cease to be such upon the death of the last settlor of the trust who is an Israeli resident, upon which the provisions applying to a “testamentary trust” will apply to it. The meaning of the change is that a trust in which the last of its Israeli settlors has died and in which all of the beneficiaries are foreign-residents, will not be liable to tax on income generated outside of Israel.
2.4 The definition of a “trust assets holding company”, for which conditions have not been imposed hitherto, was changed, and the company will now be required to fulfill two cumulative conditions: (A) it was established solely for the purpose of holding trust assets and a notice of its incorporation was delivered to the assessment officer within 90 days of the date of its incorporation and (B) the trustee holds all of its shares, directly or indirectly (through another trust assets holding company).
2.5 It has been further determined in the Budget Law that there is a duty for a beneficiary who has received distributions from a trust, to submit a tax return even if the distribution is not taxable in Israel. The reporting duty will not apply to the distribution of a foreign situs asset to a foreign beneficiary of a trust that is considered to be a foreign trust (that is taxed as a foreign resident). The meaning of this is:
An Israeli resident beneficiary will be required to submit a tax return if he has received a distribution from any trust, in money or in kind; A foreign resident beneficiary who has received a distribution of an “Israeli situs” asset from a trust that is considered as a foreign trust will be required to submit a tax return; A foreign resident beneficiary who has received a distribution from a trust that is considered to be an Israeli trust (that is taxed as an Israeli resident), in money or in kind, will be required to submit a tax return.
This change of the beneficiary’s reporting duty is already in force, as of August 1st, 2013.
3. Changes in the Real Estate Taxation law:
3.1 Within the government plan for increasing the supply of apartments, the Budget Law revises the reliefs in purchase tax and capital gain tax that is given to apartment buyers and sellers.
3.2 Relief in purchase tax will be given to a purchaser of a sole apartment, who is an Israeli individual only. In view of this, a foreign resident purchasing an apartment in Israel will not be entitled to the exemption from purchase tax up to the limit prescribed in the RETL (approximately NIS 1.5 million, which is approximately 400 thousand dollars).
3.3 Exemption from capital gain tax from selling an apartment will be granted only to an Israeli individual who possesses only one “qualifying” apartment that is the only apartment of the seller in Israel. The above exemption will be granted to a foreign individual under the same conditions, if he doesn’t own an apartment in his country of residence. An apartment may no longer be sold every 4 years with a tax exemption. The meaning of this is that a foreign resident will not be able to enjoy an exemption from capital gain tax upon selling a qualifying apartment, unless (as weird as it sounds) such foreign resident proves that he doesn’t possess any apartment in his residence country. Within the transitional provisions it has been proposed that a foreign resident will be able to enjoy relative relief at the time of sale of up to two qualifying apartments, if he owned them before January 1st, 2014.
3.4 The Budget law includes a provision that reflects the controversial position of the Israeli Tax Authority whereby relief upon exchange of Real Estate outside of Israel may not be granted. Nevertheless, at the time of selling the exchanged Real Estate, the foreign tax will be creditable against any other tax liability of the taxpayer, and tax that was paid in excess will be refunded to the taxpayer if some conditions are fulfilled.
3.5 An exemption from tax that is given to a foreign resident from the sale of shares in a private company, will not apply, when, at the time of selling, most of the company’s value is derived, directly or indirectly, from (A) immovable property situated in Israel; (B) a right to utilize natural resources in Israel; (C) a right to proceeds from immovable property situated in Israel.
4. Stricter rules applying to a transparent company for tax purposes – a “family company”:
4.1 In a nutshell, a family company is a company that is held by individuals who are members of the same family, which may be treated, at its own request, as a transparent company for tax purposes. In this case, the income is attributed to a “representative taxpayer”, who is the individual with the highest holding rate in the company.
4.2 In accordance with the current provisions of the ITO, an ordinary company may request to change its classification to a family company via a written notice to the assessment officer up to one month before the tax year (i.e. the notice is to be given by the end of November before the commencement of the tax year). In accordance with the Budget Law, a company will be able to be classified as a family company, if it notices the assessment officer of its election within 3 months of its incorporation date. The meaning of the proposed change is that existing companies will not be able to become family companies except within the transitional provisions that have been prescribed in the Budget Law (and at the same time a mechanism of deemed sale of assets and deemed distribution of dividend has been determined, with some exceptions).
4.3 In accordance with the current provisions of the ITO, a family company may change its classification to an ordinary company via a notice to the assessment officer until the filing date of the annual tax return, and this does not prevent it from resuming its family company status in the future (there is a three year cooling-off period in force). In accordance with the Budget Law, a company that will cease to be a family company will not be able to become a family company again.
