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TaxationWeb by Alon Kaplan and Jimmy Chotoveli

Israel has this year altered its basis of taxation for individuals introducing taxation of worldwide income and capital gains. Yet, as this article demonstrates Israel retains many helpful exemptions and with careful planning, Israel can still be a useful place for either permanent or temporary residence. In this context UK residents may consider it a location for avoiding income and capital gains from the sale of a business, or an exceptional income stream in a single tax year.Alon Kaplan and Jimmy Chotoveli
of Alon Kaplan Law Firm, Israel

The Israeli business scene is part of the western commercial world. While Israel is not a "tax haven", the Israeli government makes every effort to encourage foreign investment and trade, inter alia, by providing generous tax exemptions for foreign investors and immigrants.

I. The Israeli Tax Reform
The date January 1, 2003 will be remembered as the start of a new "tax era" in Israel. Until the end of 2002 the Israeli tax system was based on the territorial principle, i.e., income liable to tax in Israel was income that was "accrued" or "received" in Israel. That meant that Israelis and foreign residents could enjoy foreign income and gains tax free. The new legislation introduced the principle of personal global taxation. Under this system, Israeli "residents" will pay tax in Israel on worldwide income.

II. The Test of Residence
The new tax legislation provides that an individual shall be treated as an Israeli resident for tax purposes, if his "centre of life" is in Israel. When determining this issue, the tax authorities examine two tests: quantitative and qualitative.
Under the quantitative test, the legislation states that an individual's "centre of life" is in Israel if he is either present in Israel for 183 days or more in a given tax year, or 30 days or more in a tax year and a total of 425 days or more during that and the two previous tax years.
However, this quantitative test shall not be regarded as conclusive. The Israeli tax authorities also apply a number of auxiliary qualitative criteria in order to fully examine the individual's family, economic and social ties to Israel. This framework includes, inter alia, an evaluation of the following:
* Location of the individual's permanent home;
* Location of the individual's actual home and that of members of
his family;
* Location of the individual's fixed or permanent business or work;
* Location of the individual's economic interests;
* Location of the individual's activity in organisations,
associations and institutions.
The practical application of these tests by the Israeli tax authorities and courts will be followed closely by tax practitioners. The legislation is relatively new and due to lack of precedents, practitioners will rely on case law from the previous tax system which principally adopts the "centre of life" rules.
We can now turn to examine how foreign, new and returning residents are taxed under the new tax system.

III. Taxation of Foreign Residents
The new income tax legislation states that a foreign resident will be liable to tax on income "accrued" or "received" in Israel.
However, foreign residents are subject to numerous tax exemptions.
For instance, they are able to receive tax free interest on foreign currency deposits at Israeli banks if, inter alia, the following are fulfilled:
* The foreign resident does not have any partners in the bank account who are not foreign residents;
* The foreign resident has declared by the start of the tax year or within 14 days of the opening of the bank account, whichever is later, that he is a foreign resident;
* The deposit in the bank account was not used for granting of a loan or as a guarantee for a loan that was given by the bank to the foreign resident's relative or company that is controlled by the foreign resident, if they are residents of Israel.
Foreign residents also enjoy tax-free income derived from investments in the Israeli stock market and certain mutual funds, subject to exceptions.

IV. Taxation of New Residents (Immigrants) and Returning Residents
A "new resident" is a person who acquires the status of an Israeli resident for the first time. A "returning resident" is a person who ceased to be an Israeli resident and lived on a permanent basis outside Israel during at least three consecutive years and subsequently returned to Israel.
New residents and returning residents are eligible for the following tax benefits.
A. Business Income
A new resident is exempt from income tax for four years from the date of arrival, in respect of the income from a business he possessed outside Israel for at least five years prior to arrival.
B. Non-Business Income
A new resident is also entitled to a tax exemption on passive income (e.g., interest, dividends, royalties, rental fees and pensions) for five years from the date of arrival, provided the income is derived from assets which he possessed prior to arrival. This exemption also applies to a returning resident in respect of assets acquired outside Israel during the period of residence abroad, after ceasing to be an Israeli resident.
Furthermore, new residents will benefit from tax concessions on pensions received from abroad up to the tax level they would have been obliged to pay abroad.
C. Capital Gains
New residents are exempt from capital gains tax on the sale of an asset located outside Israel which was in their possession prior to arrival, provided the asset was sold within 10 years from date of arrival. The exemption also applies to returning residents in respect of assets acquired outside Israel during the residence abroad.

V. Emigration/Departure Tax
The tax reforms have introduced new rules for taxing individuals (as well as companies) who cease to be Israeli residents after January 1, 2003.
The legislation provides that an asset which was owned by an Israeli resident will be deemed to have been sold on the day of departure. The individual may choose to defer the payment of the capital gains tax to the date of actual sale. In such an event, the taxable gain will be the real gain at the date of actual sale proportionate to the period from the date the asset was purchased to the date the residency ceased.

VI. Double Taxation Relief
Israel is a party to more than 35 tax treaties. The new tax reforms have not affected the existing treaties.
Where a taxpayer is taxable both in Israel and abroad in respect of the same income, double taxation relief may be available either in accordance with a bilateral tax treaty (convention) or, in certain cases, unilaterally.
In general, double taxation relief may take the form of a credit for overseas taxes (the credit method). Many of Israel's tax treaties allow investors to take a full foreign tax credit even if the rate has been reduced in Israel as an investment incentive under the Encouragement of Capital Investments Law. This is known as "tax sparing" relief.

VII. Conclusion
While Israeli residents face a heavy tax burden on their worldwide income due to the tax reforms effective from January 1, 2003, it can be seen that the Israeli government makes every effort to attract foreign residents to invest in Israel and help the economy grow. In parallel, the Israeli government seeks to attract ex-Israeli residents and provides them with numerous tax advantages when returning to Israel. We can conclude that the Israeli Tax Inspector is reasonably "tax friendly" to new, foreign and returning residents.
Individuals wishing to seek advice as to their status and tax liability are advised to consult local professionals in this field.

Alon Kaplan, LLM, practices as an Advocate in Tel Aviv. Mr. Kaplan is also a member of the New York Bar and practices law in Germany as a Rechtsbeistand. Mr. Kaplan is Chairman of the Israeli Branch of the Society of Trusts and Estate Practitioners (STEP) and a Council member of STEP .He is Editor of "Trusts in Prime Jurisdiction", Email: alon@kaplex.com.

Jimmy Chotoveli, LLB, MSc, is currently doing his Articles at Alon Kaplan Law Firm, Tel Aviv, Israel. Email: jimmy@kaplex.com.