This article provides an overview of the tax benefits Israel provides returning residents, Olim and companies they control. The article will detail who is entitled to benefits and what those benefits are. Finally the article will review the main issues that often arise during the planning stage prior to moving to Israel.
In 2008 the Knesset approved Amendment 168 to the Income Tax Ordinance, which provided significant tax benefits to new immigrants and returning residents who moved to Israel after January 1, 2007.
There are three types of people eligible for tax benefits: “new immigrants”, “veteran returning residents” and “returning residents”.
“New immigrant” is one who was never a resident of Israel and became a resident of Israel for the first time.
“Veteran returning resident” is a person who was a resident of Israel, then left and was a foreign resident for at least 10 consecutive years and then returned to be a resident of Israel. However, a person returning to Israel between January 2007 and December 31 2009 will be considered a veteran returning resident if that person was abroad for a period of at least five years.
“Returning resident” is a person who returned to Israel and became an Israeli resident after being a foreign resident at least six consecutive years. However, residents that left Israel prior to January 1 2009 will be considered as returning residents entitled to the tax benefits even if they were foreign residents for only three consecutive years.
What are the benefits?
According to Amendment 168 new immigrants and veteran returning residents are entitled to broad tax exemptions for a period of ten years from the day they become Israeli residents. The exemptions apply to all income which originates from outside of Israel. The exemptions apply to passive income (dividends, interest, and capital gains tax) and active income (employment, business profits, services).
A person meeting the definition of “returning resident” is entitled to fewer benefits. The benefits are tax exemptions for five years on passive income produced abroad or originating from assets outside Israel. The main exemptions are:
• Exemption for five years on passive income from property acquired while a foreign resident. Passive income includes things like royalties, rents, interest and dividends.
• Exemption for 10 years on capital gains from the sale of property which was purchased while the person was a foreign resident.
What is the definition of “foreign resident” and do visits to Israel during the period of foreign residency jeopardize the benefits?
In order to create certainty and to allow people living abroad to plan their move to Israel, Amendment 168 defines who is a foreign resident. A Foreign resident is a person who meets these two criteria:
1. Was abroad for at least 183 days per year for two years.
2. A person whose center of life was outside Israel for two years after leaving Israel. (The term “center of life” will be explained below).
Will visits to Israel cut off the sequence of foreign residency, thus endangering the benefits?
The answer is no. Visits to Israel will not endanger the status of foreign residency as long as the visits are indeed visits. If the visit begins to look live a move, both in terms of length and nature, then the Israeli tax authorities may see the visits as a shift in center of life.
Foreign companies owned by new immigrants and returning residents Veteran
According to Israeli Income Tax Law, a company incorporated in Israel or controlled or managed in Israel is deemed a resident of Israel and thus taxed on worldwide income. Therefore, without a clear exemption for foreign companies owned by veteran returning Israelis or Olim, these companies would often be taxed on worldwide income once their owners moved to Israel. This situation led the Knesset to include in Amendment 168 the provision stating that a foreign company will not be considered a resident of Israel solely because of one’s move to Israel. So long as the company is not clearly controlled or managed in Israel, it is entitled to the exemption for income produced outside Israel. Of course, if management and control are in Israel then the company is deemed an Israeli resident and taxed on worldwide income. Also, if the Company produces Israel sourced income, it is taxed on that income.
The following are common tax-related issues encountered by people planning their move to Israel:
1. At what point does a person go from being a non-resident to a resident of Israel? As noted above, the “center of life” test determines whether a person is a resident of non-resident of Israel. The center of life test involves a complex balancing of many aspects of a person’s life – family, personal and economic. The test takes into account a range of components such as the person’s residence, place of residence of the family, main place of business place, center of economic activity, etc.
The test is not black and white but grey, as people in the midst of moving have contacts and activities in at least two countries. But a person planning to move to Israel can and should plan his steps carefully. For example, a person who has lived abroad since June 2004 and who returned to Israel several times in 2009 to plan a return to Israel in 2010 would want to establish a “center of life” shift in 2009. This would entitle the person to the expanded rights of a veteran returning resident. If planned and documented planning, one can definitely take advantage of the fluid nature of the center of life test to achieve the maximum benefits.
2. Where are revenues generated? All exemptions are granted on income produced outside of Israel. Exemptions do not apply for income produced in Israel. When is income considered produced in or outside of Israel? In the case of passive income, dividends or interest received from a foreign company abroad are likely to be deemed produced abroad. The same is true for capital gains. If a foreign resident bought a house abroad and sold it after becoming a resident of Israel, the gain will likely be exempt from capital gains tax in Israel.
What about a resident of Israel who earns income from work or services performed outside of Israel? What happens if a person owns several pieces of real estate abroad and moves to Israel and manages the real estate from Israel? Again, the exemption is granted only to income from work or services that are earned outside of Israel. In cases where work is performed both in Israel and abroad, the person may be required to split the income into two parts and pay income tax on the portion that is Israel-sourced. Of course, here there is room for much planning. Today, in the Internet age, one can perform work in Israel without creating any footprint. Add in a few periodic flights abroad and it might be possible to establish that all the income was earned abroad.
3. How to “pacify” income that is generated by an active business abroad? As stated above, a regular (non-veteran) returning Israeli is entitled to exemptions only on passive income. But what if the person has an active business abroad? That person can sell the business and thus be entitled to the capital gain exemption Israel provides. But this might not be the ideal solution as capital gains tax in the foreign country may apply on the sale. Also, the returning resident may prefer to keep the business and enjoy the cash flow it generates. In this situation various creative solutions can be tailored to meet the person’s unique situation and business.