The Israeli Knesset has just passed an amendment which will raise Israeli tax rates for many in 2012. This is pursuant to the Law for Change in the Tax Burden (Legislative Amendments), 2011 (Book of Laws 2324, December 6, 2011).
The amendment follows peaceful but earnest demonstrations in Israeli streets last summer calling for lower living costs, and recommendations of a Commission headed by Manuel Trajtenberg.
The higher tax rates are meant to finance some of the reforms considered necessary. The measures enacted are similar to the bill sent to the Knesset but include important differences.
What are the main new measures?
Here is an overview of the new Israeli tax measures which take effect January 1, 2012:
Company tax: The company tax rate on profits will be increased from 24% to 25%, and future scheduled reductions are repealed.
Personal income tax: The top rate of income tax will rise from 45% to 48% on annual income from business or employment over NIS 489,480 (this will be adjusted shortly for inflation). Middle class earners will pay 21% tax instead of 23% on the NIS 103,929 – 168,840 annual income bracket. The proposed rate of 50% for people earning NIS 1 million was not enacted. Future scheduled tax rate reductions were repealed;
Personal national insurance (social security) : The upper income limit for national insurance contributions will be reduced to NIS 489,480 which will coincide with the above 48% income tax threshold;
Working fathers: Working fathers will receive extra ‘‘credit points‘‘ (personal tax allowance) one point in the year of birth; two points in each of the next two years; one point in the year the child reaches three years old. Each point saves tax of around NIS 209. It apparently doesn‘t matter if the father isn‘t married and doesn‘t have custody of the children. This is not chauvinistic as working mothers already receive extra points.
Investment income: The regular tax rate on dividends, interest, loan discount, capital gains and land appreciation will go up 5% for individuals. The regular rate will increase from 20% to 25%. The rate for dividends paid to major shareholders (holding 10% or more) will increase from 25% to 30%. These rates will generally also apply to foreign investors subject to any applicable tax treaty. A 30% tax rate will generally also apply to sales of shares in real estate entities by major shareholders. Nevertheless, a 15% tax rate will continue for income from investments not linked to inflation or a foreign currency if the taxpayer is not a major shareholder of the payor. Marginal rates of tax (up to 45% plus national insurance) will continue to apply to interest income in various circumstances (expense to payor, recipient is major shareholder, business income, employment or supplier-customer relationship, etc).
Transitional measure for savings plans, deposits and certain life policies: The interest on savings plans and deposits that were ‘‘approved and opened‘‘ before the amendment was published (December 6, 2011), will be taxed at the old rates until the first withdrawal date that is not subject to an early withdrawal penalty. It is unclear if this applies to foreign savings plans or deposits. It is interesting to note that the definition of savings plan in the Income tax Ordinance includes ‘‘the savings element of a life insurance policy, or a savings plan attached to such a policy and approved by the Insurance Comptroller under the Insurance Business Regulation Law, 1981‘‘.
Transitional measure for certain capital gains: In general, the new tax rates for capital gains will apply to the pro rata portion of inflation adjusted capital gains arising after the rate increase on January 1, 2012, on a time-apportionment (‘‘linear‘‘) basis – but not in the case of publicly traded securities or units in ‘‘exempt‘‘ mutual fund (the investor pays tax, not the fund). For example, if a taxpayer acquired 10% or more of the shares of a private company at the beginning of 2011 and sells them 2 years later at the end of 2012, 50% (one year‘s worth of holding before January 1, 2012) of the inflation adjusted gain will be taxed at the old rate (25%), and 50% (one year‘s worth of holding after January 1, 2012) of the inflation adjusted gain will be taxed at the new rate (30%).
Investors in publicly traded securities an d ‘‘exempt‘‘ mutual funds may elect in December 2011 to sell and repurchase them an off-market transaction at the old (lower) tax rates; this is sometimes known as a ‘‘virtual sale‘‘ or even ‘‘bed and breakfast.‘‘
The deemed sale price is the closing price at the end of the day in the case of securities and at the end of the previous day for exempt mutual fund units. Not all the portfolio needs to be sold, but the virtual sale election can only be for all the securities or units of a particular type (e.g. of a particular company) and they must all be repurchased. Therefore, you need to have the cash from other sources to pay the tax arising on the virtual sale.
Going forward, the virtual sale date and price will be treated as the purchase date and cost of those securities or units for Israeli tax purposes.
The virtual sale must be done via a stock exchange member, which the Israeli Tax Authority (ITA) interprets (in an announcement dated December 7, 2011) to mean a member of the Tel-Aviv Stock Exchange – as they must withhold the capital gains tax and remit it to the ITA. Pre-2005 capital gains on foreign securities are taxed at 35%, but it is unclear if such members have the software to collect this tax.
The ITA announcement goes on to clarify that the virtual sale election is available to individuals and companies, regarding shares, and bonds publicly traded in Israel or abroad, ‘‘exempt‘‘ mutual fund units (presumably Israeli only…), and Israeli government bonds.
The ITA announcement says that the virtual sale election is not available to: securities dealers, nor employees or service providers who received their securities in consideration for services if they are subject to a reduced rate of tax by law. The basis for saying this is unclear if the appropriate tax was paid upon receipt of the securities. Holders of stock options on the ‘‘capital track‘‘ (still 25% tax) should seek appropriate advice.
If foreign mutual fund units are involved, or a Tel-Aviv stock exchange member is not used, or if you don‘t want to repurchase everything you sold (e.g. to pay the tax arising), consider an actual sale rather than a virtual sale.
Other detailed measures:
Withholding tax hastily introduced on March 31, 2011 on real estate deals at rates of 7.5% – 15% will be dropped on April 1, 2013. Proposals to increase these rates were not enacted.
Upon a sale of assets acquired before April 1, 1961 by individuals, the rate of capital gains tax or land appreciation tax will rise according to a prescribed formula. The nominal capital gain (unadjusted for inflation) remains taxable at 12% in the case of assets acquired up to March 31, 1949. If the purchase was purchased in the years after then, the number of such years is counted. It appears the 12% rate will be increased by 2% per year counted if the sale is in 2012, 3% per year counted if the sale is in 2013 or 2014, but the result should not be more than the regular tax. Different rules apply to companies and individuals in certain cases. The provisions are complex and we await clarification from the ITA.
Certain pensioners will enjoy a larger exemption for interest on deposits or savings plans.
Comments and Tips:
Consult advisors: Holders of public securities of all types should consult their investment and tax advisors now about virtual or actual sales in 2011.
Take dividends in 2011: Shareholders of public and private companies in Israel and abroad should consider taking a dividend from their company before the end of the year, in order to cash in on the old (lower) tax rates. Suppose a company you control accumulated a profit after tax of NIS 1 million every year for the last 10 years. If the company pays you a dividend of NIS 10 million in 2011, the Israeli tax will be NIS 2.5million (25% of all those years‘ profits). If you wait till 2012 to receive the dividend, the tax will rise to NIS 3 million (30% of all those years‘ profits)
Accelerate other income, postpone expenses: Consider also accelerating interest payments and capital gains where legitimately possible into 2011. Consider also postponing expenses until 2012.
Foreign investors: Foreign (non-Israeli resident) investors who acquired public or private Israeli securities after January 1, 2009 are generally exempt from Israeli capital gains tax, so virtual sales are probably not for them. No exemption applies in the case of investments related to Israeli real-estate or by a permanent establishment (i.e. trading) in Israel. If the investment was acquired in the period July 1, 2005 – December 31, 2008, such an exemption was possible if the investor resides in a country that has a tax treaty with Israel and the investment was notified to the ITA within 30 days. Foreign investors should check the provisions of any tax treaty between Israel and their country of residence and take specialist advice.
Company vs. freelancer: Operating as a company may still be preferable to operating as a self-employed freelancer. Tax rates on distributed profits of both will approach 48%, but there may still be national insurance savings on dividends, albeit up to a lower-income limit. And companies confer limited liability.
Business tax breaks: Israeli tax breaks remain unchanged for ‘‘preferred enterprises‘‘ and ‘‘privileged enterprises‘‘ in industry, tech or tourism – anywhere in Israel – pursuant to the Law of Encouragement of Capital Investments, 1959. These can result in company tax of only 10%-15% and dividend withholding tax of only 15% if certain conditions are met.
Immigrants: Immigrants will continue to enjoy an Israeli tax exemption of up to 10 years on foreign-source income and gains. They will suffer the same higher Israeli tax rates as other Israeli residents on Israeli source income and gains. There is a possible exemption for capital gains on Israeli source securities if they were acquired before they became Israeli residents. Specialist advice is recommended.
As always, consult experienced tax advisers in each country at an early stage in specific cases.
Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.