5 Tax traps for Israelis abroad

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The tax system in Israel is “personal”. That means as long as an individual maintains his residency (to distinguish from Israeli “citizenship”) for tax purposes, then he is required to pay taxes on his income worldwide, from all sources of income, of whatever source. In this article I should mention five widespread traps of someone who did not know how to disconnect his residency for tax purposes, as Income Tax expects disconnection of residency, i.e. he will be considered as an “Israeli resident” despite the fact that he lived abroad.

  1. Annual tax returns to Income Tax:

         An Israeli resident who produces income abroad, is required to submit an income tax return in Israel and to pay the tax accordingly. Although it is possible to deduct certain expenses, and to be credited for taxes paid abroad (although not always the full amount), but it is clear that the first trap will be the actual obligation and bother to file an annual return to Income Tax (often as a result also of a long chain of events such as a capital declaration, tax advances and various and varied reports).

  1. Reporting an indebtedness to National Insurance:

         It is highly likely that an individual is also liable to be considered an Israeli resident for national insurance purposes and will be required to pay insurance fees (in addition to national health insurance) on his income abroad, depending on circumstances. Should an individual pay national insurance abroad, he will not be able (in the absolute majority of cases) to set this off against the national insurance in Israel, and certainly not with payments of national health insurance. For this reason, often this “blow” of double national insurance is liable to be more harmful than income tax.

  1. “Exit tax” (or “leaving tax”):

         The law requires anyone who has financial assets, or real estate assets abroad, to pay income tax in Israel and to pay to the Income Tax Authorities in Israel the tax on part of the profits relating to Israel, even if realizing the profits occurred when the individual was already a foreign resident. In many cases this is expressed in exercising options to shares that employees received in Israel and which were exercised abroad (and by the way –also on return to Israel). The distribution of profits, whether it is liable to tax in Israel or exempt, is calculated in a linear way according to the period of holding, up to the date of discontinuation of Israeli residency. But this is exactly the question: What is this day? Not necessarily the day on which the individual traveled abroad. Moreover, when this relates to options for shares held by an Israeli “trustee”, then the trustee will deduct the tax from any profit. The employee is entitled to obtain from the Tax Authorities a “tax adjustment” to reduce the tax for the share of the profit that should be related to profit abroad. This is a critical time in which the whole subject of discontinuing residency is liable to be examined with all the consequences.

  1. Tax benefits to a returning resident:

         Income Tax grants tax benefits to a returning resident for a certain period on his income from assets held abroad, which were acquired when the individual was a foreign resident and continues to hold these assets after returning to Israel (these benefits will be considerably expanded from the 60th birthday of the State). A basic condition for these tax benefits is that the individual was a “foreign resident” for sufficient years. i.e., it is possible that the individual stayed abroad for a number of years, but when he returns he will not be entitled to tax benefits as he did not know how to properly discontinue his residency for tax purposes from the beginning: As a “foreign resident” he stayed abroad less than the minimum period set forth in the law.

  1. Operations abroad through a company established abroad:

         This trap is rarer, but it exists. The Law stipulates that in specific cases operations abroad through a company owned by an Israeli resident is likely also to be liable to tax in addition to the income of the Israeli individual himself.

Determining the status of residency for tax purposes raises the need to thoroughly examine the following tests: When and how the individual discontinuous his residency? The significant tax consequences are from the Israeli residency to foreign residency (in order to avoid payment of tax in Israel on income abroad and the double liability for national insurance), and in order to enjoy the tax benefits when returning as an Israeli resident.