Tax Alert No. 3 - 25.12.2008

Amendment No. 168 to the Israeli Income Tax Ordinance (“ITO“) was finally enacted on September 16, 2008 (the “Amendment” or “Reform“). As we previously detailed, the Reform provides significant tax benefits to New Immigrants “Olim“) and former Israeli residents who resided at least 10 years outside Israel (“Long-Term Returning Residents“). Below we have outlined the main aspects of this tax Reform, as included in the legislation.

A special “window of opportunities”

This almost ending period is offered to  former Israeli residents that will  returns to Israel until 31.12.2009; those may enjoy similar tax benefits as “Long-Term Returning Residents” provided they have been foreign residents for at least 5 years prior to their return to Israel;

Individuals eligible for the extensive benefits package

• “Israeli Resident for the First Time” – An individual that was never a tax resident of Israel;
• “Long-Term Returning Resident” – a former Israeli resident individual returning after being a foreign resident for at least 10 years.

Complete income tax exemption

Full exemption may apply to all types of foreign-sourced income:

• Passive income and capital gains deriving from foreign assets (including those acquired after immigrating to Israel);
• Business income and income from employment and professional services carried outside ofIsrael);

Extension of exemption period

• Eligible individuals may enjoy a tax exemption for a period of 10 years from the day of establishing Israeli residence (the one-year adaptation period is counted for this purpose).
• Prior to the Amendment – the exemption period was 5 or 10 years.

Waiver of any reporting or tax filing requirements

• Annual tax returns – related to foreign sourced exempted income only.;
• Declaration of capital – with respect to foreign assets only.
• Settlor’s notice regarding the settlement of a trust or transferring an asset thereto (foreign assets only).

One-year “adaptation period” is provided

• An individual may elect not to be considered an Israeli tax resident in the first year of residence in Israel. This year, however, is included within the 10 years of exemption.
• A notice on the election must be submitted to the authorities (within 90 days upon arriving toIsrael).
• At the end of the adaptation year, the individual may leave Israel without triggering Israeli tax implications.

Effective Date

• The Amendment applies as of 1.1.2007 and in relation to individuals who become Israeli tax residents from this day onwards (certain provisions carry a different effective date).

Secondary benefits package

• Offered to a “Returning Resident”, i.e.: former Israeli resident returning to Israel after being a foreign resident for at least 6 years. The 6 years requirement pertains to individuals who ceased to be Israeli resident as of 1.1.2009.
• Under a transitional provision, a period of 3 years (the period required prior to the amendment), will continue to apply to those have ceased to be Israeli resident prior to 1.1.2009.
• 5 years tax exemption for passive income (including interest and dividend from traded securities within “a closed bank account”);
• 10 years tax exemption for capital gains (including from traded securities within “a closed bank account”);
• Pertains only to income from foreign assets acquired while being a foreign resident.

On December 15, 2008 the Kenesset Committee of Finance (a committee of the parliament) has authorized the government’s Economic Enhancement Program of 2008 (the “Enhancement Program“). The Enhancement Program will become legally effective only after the Israeli Income Tax Ordinance is ammended by the Kenesset.

The Enhancement Program includes a tax benefits package, which offers significant tax reduction in relation to repatriation of funds to Israel, as well as additional provisions aimed to encourage foreign residents to invest in the Tel Aviv Stock Exchange (“TASE“).

The main tax benefits to be offered by the Enhancement Program are:

• Non Israeli residents will enjoy a full tax exemption on interest income from bonds / debentures traded in TASE.
• A full capital gains tax exemption to non-Israeli resident investor on gains from any Israeli securities, provided that these securities were not issued by “Israeli real estate companies” (i.e., companies the main assets of which are real estate assets located in Israel) and provided that the disposed securities may not be classified as an income of an Israeli permanent establishment of a non-Israeli head office / company.
• A reduced corporate income tax rate of 5%, instead of 25%, on dividends received by an Israeli resident company from a non-Israeli resident subsidiary. This reduced rate shall apply only to dividends received during 2009 (according to a planned Provisional Order) provided that the received dividend amount is used to invest in the domestic economy (as shall be defined by law).  “Eligible investment” is planned to include salary payments, rental expenses for business purposes and
  the purchase of business assets.

In this respect, it should also be noted that the capital gains tax exemption under Section 97(b3) of the ITO, which is currently provided to non-Israeli residents, with respect to certain securities and rights in Israeli resident companies or non-Israeli resident companies which most of their assets are located in Israel , refers only to asset acquired between January 1, 2005 and December 31, 2008. Therefore, this provision does not apply to assets that will be acquired from January 1, 2009 onwards. However, the ITA examines the possibility to extend the purchase period in this provision, since such an extension is in line with the main principles of the Enhancement Program.

Recently (November 27, 2008), the Tel Aviv District Court issued its decision in the Telrom case (Income Tax Appeal 1061/2007, Telrom Human Resources Ltd. v. Tel Aviv Tax Assessing Officer).

In its Telrom decision (the “Decision“) the court refers to the interpretation of the term “resident” for the purpose of determining the status of a “foreign worker” in the Israeli “Charge Law” (a law that imposes a certain charge (levy) on Israeli employers of “foreign workers”.

The “Charge Law” imposes the said levy only in case the foreign employee is neither an Israeli citizen nor an Israeli resident.

The appellant argues that in case a foreign worker is an Israeli resident for tax purposes (under the ITO), the said levy should not be imposed.

The court rejected this argument while examining the term “resident” and interpreting this term in the context of the legal area it intends to serv. In other words, the term “resident” for the purposes of the “Charge Law” does not necessarily bear similar meaning as it may have under the income tax code.

While referring to methods of interpretation of legal terms, the court distinguishes between a referral to another legal source and absorption of a term from other legal sources. According to the court, a referral to another law should include a referral to another law as a whole and in its entirety.  This is necessary in order to correctly implement the most suitable interpretation of the relevant term as it is meant by the legislator of the “other” law.

The court precisely states that while defining a term through the referral method of interpretation: “the referral would be performed only following an analysis of the components of the definition in the other legal source as a whole, which is not separable … while examining the mentioned law, (i.e., the term in its context in the other legal source – A&H) the interpretation outcome should finally be taken into the referring law. … the content of the legal term, including its entire developments should be copied into the referring law” … (free translation from Hebrew – A&H).

Accordingly and following this reasoning, it may certainly be argued that in case the ITO refers to a foreign legal source or a foreign tax law provision, such a referral should mean an acceptance of the legal definitions and “results” of a specific tax term, as indicated and interpreted under the foreign law.

For example, the reference under Section 5(5)(c) of the ITO to the tax laws of a treaty country (a country with which Israel has concluded a tax treaty) for the purposes of determining “gains”,  “income” and “taxable income” of a Foreign Resident Occupation Company under the ITO must also include the foreign rules,  regulations and decisions that apply in the treaty country in order to determine the amount of income, the taxable amount and the amount of tax to be imposed by the relevant foreign tax authority.  Consequently, the foreign law should be accepted by the Israeli authorities as it is in the foreign jurisdiction with out any Israeli tax law interpretations or deviations in relation to the classification of income, the determination if there is a taxable income or even if a taxable event has actually occurred. for instance, in certain jurisdictions the domestic law does not classy a merger between companies a as taxable event and ,therefore, in case of  treaty country – Israeli CFC rules should not be imposed on “passive income” that may be triggered according to Israel’s tax law only.  Any contradicting point of view may jeopardize, according to our understanding, the intention of the Israeli legislation and the legal aim of the Israeli as well as the foreign law in the said scenario.

On December 15, 2008 the Kenesset Committee of Finance (a committee of the parliament) has authorized the government’s Economic Enhancement Program of 2008 (the “Enhancement Program“). The Enhancement Program will become legally effective only after the Israeli Income Tax Ordinance is ammended by the Kenesset.

The Enhancement Program includes a tax benefits package, which offers significant tax reduction in relation to repatriation of funds to Israel, as well as additional provisions aimed to encourage foreign residents to invest in the Tel Aviv Stock Exchange (“TASE“).  

The main tax benefits to be offered by the Enhancement Program are:

• Non Israeli residents will enjoy a full tax exemption on interest income from bonds / debentures traded in TASE.
• A full capital gains tax exemption to non-Israeli resident investor on gains from any Israeli securities, provided that these securities were not issued by “Israeli real estate companies” (i.e., companies the main assets of which are real estate assets located in Israel) and provided that the disposed securities may not be classified as an income of an Israeli permanent establishment of a non-Israeli head office / company.
• A reduced corporate income tax rate of 5%, instead of 25%, on dividends received by an Israeli resident company from a non-Israeli resident subsidiary. This reduced rate shall apply only to dividends received during 2009 (according to a planned Provisional Order) provided that the received dividend amount is used to invest in the domestic economy (as shall be defined by law).  “Eligible investment” is planned to include salary payments, rental expenses for business purposes and
  the purchase of business assets.

In this respect, it should also be noted that the capital gains tax exemption under Section 97(b3) of the ITO, which is currently provided to non-Israeli residents, with respect to certain securities and rights in Israeli resident companies or non-Israeli resident companies which most of their assets are located in Israel , refers only to asset acquired between January 1, 2005 and December 31, 2008. Therefore, this provision does not apply to assets that will be acquired from January 1, 2009 onwards. However, the ITA examines the possibility to extend the purchase period in this provision, since such an extension is in line with the main principles of the Enhancement Program.