The Israeli Tax Authority (ITA) has found a controversial back-door way of retroactively reducing the ten year Israeli tax exemption for foreign income of Olim, in the tenth year. They did so by issuing new “reportable tax positions” on December 30, 2019 regarding 2019 onwards. Does the Israeli Tax Authority lack the authority to do this?
What are Reportable Tax Positions?
A reportable income tax position is a position contrary to a position published by the ITA by the end of the year concerned if the tax advantage exceeds NIS 5 million in the tax year or NIS 10 million over 4 years.
So if your tax planning is at odds with an ITA position, you must tell them on Form 1346 – aka “the come and get me” form.
However, no reporting is needed from certain Israeli charities, nor from individuals or companies with income below NIS 3 million or capital gains below NIS 1.5 million in the tax year.
Reportable income tax positions must be reported within 60 days after filing the main annual income tax return..
What are the new Positions impacting Olim?
Controlled foreign company (CFC): Israeli 10%-or-more investors in a passive CFC that is over 50% owned by Israeli residents and pays tax of 15% or less may be taxed on deemed dividends from the CFC. Until now Olim have been treated like foreign resident investors and therefore exempt for 10 years from their arrival. Now the ITA’s position is that a deemed dividend arises on December 31. If the ten year tax holiday expired during the year, no tax holiday applies to CFC income that entire year (January-December), regardless of when the income was earned, according to the ITA. For example, if your tax holiday finished on September 1, 2019 you are taxed from January 1 not September 1, 2019. This reduces the tax holiday.
Foreign professional company (FPC): Israeli 10%-or-more shareholders carrying out a “special profession” (most services) via foreign company 75% owned by Israeli residents may be taxed on deemed dividends from the FPC. Now the ITA’s position is that if the ten year tax holiday expired during the year, no tax holiday applies to FPC income that entire year, as above.
Trusts: In a Relatives’ Trust with a foreign resident settlor (grantor) and a related Israeli resident beneficiary, it is possible to pay Israeli tax at 30% only when trust income is distributed, or no tax if the beneficiary is in his ten year tax holiday. The ITA’s position is that the 30% tax applies to distributions after the beneficiary’s tax holiday is over, even if the trust generated the income during the tax holiday period.
Adam and Eve first became Israeli residents on September 1, 2009 and their kids started school in Israel then. They must file Form 1346 with the ITA if they claim the Aliya exemption for deemed dividends from a real estate CFC abroad, if the tax advantage exceeds NIS 5 million (i.e. the income or gain was probably over NIS 15 million).
Boruch finished his Aliya tax holiday on September 1, and on September 2 he received a small distribution of NIS 10,000 from a trust settled by his father living in the US. This distribution may be taxed at 30%.
Section 14 of the Income Tax Ordinance says: “An individual who became a new Israeli resident or a senior returning resident (lived abroad 10 years) shall be exempt from tax for ten years from the time that they became Israeli residents … on income from all sources ….which were accrued or derived outside Israel….”. The rules on CFCs and FPC’s deem an Oleh to be a foreign resident for the duration of the Section 14 exemption period (ITO Sections75B -75B1).
There is apparently no section in the law that expressly says the ITA can stop tax breaks on January 1 in year 10 of the Aliya tax holiday.
A new reportable tax position issued at the end of 2019 may seem like retroactive legislation, but it isn’t even that. The ITA is imposing its own aggressive interpretation under secondary regulations aimed at revealing hidden tax shelters, not reducing legitimate tax benefits passed by the Knesset. Olim may wonder what will the ITA take away next?
What should you do?
Olim might consider bringing forward foreign sales, distributions and tax planning generally (with their advisors) to year 9 rather than year 10 of the tax holiday.
Please contact us for a detailed review in specific cases.
Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd
(c) January 30, 2020