Income Tax in Israel defines an “Israeli resident” for tax purposes using to the term “center of life”. In addition, the law stipulates presumptions of residency according to the number of days the taxpayer stays in Israel in the current year. Income Tax stipulates therefore, that an Israeli moving abroad, is likely to still be considered (he and his family) as an Israeli resident for tax purposes, even if he already lives for a certain period abroad. The meaning of determining Israeli residency is the obligation of an employee to report to Income Tax in Israel on his income worldwide, and his liability for national insurance in Israel. Determining the date of change of residency is not simple due to the complex system of tax laws in Israel and abroad, various regulations, tax treaties, professional circulars, procedures, practice and the theoretical and oral law.
The following are three real examples of the considerable financial consequences of defining residency for tax purposes.
First example – Options for shares for an employee
A.I., an employee in a high-tech company, while in Israel he participated in an options plan for shares in the Company in which he is employed (some of the options are through a trustee as part of an arrangement with Income Tax in Israel and some without a trustee). During the vesting period he moved with his family to the US. There too, he received additional options as part of the plan for American employees.
A few years later he A.I. returned to Israel. During most of the period the employee requested to exercise the options to shares and to realize them. To his surprise, it became clear to him that without the approval of the Tax Authorities, tax will be deducted at the full rate on the full profit from realizing the options and the shares.
Income Tax examined the date of change of residency according to many criteria (such as the tax returns in Israel and the US, national insurance and labor agreements, permanent home, personal family and community center of life, bank accounts, savings and credit cards and more). After submitting the documents and a discussion, Income Tax agreed to approve a tax exemption on part of the profit from exercising the options proportionally to the vesting period as a foreign resident. In this way A.I. saved tax of over a million shekels.
Second example – Refunds of tax in Israel
D.I. worked for an Israeli company and after a period of time was sent to its American subsidiary. During the year of relocation he worked in Israel for only part of the year and naively submitted, at the beginning of the next year a claim for repayment of tax to an employee due to the part of the year he had not worked in Israel.
To his surprise Income Tax returned the application for a refund of tax unapproved, as long as he did not report on his income for the whole year. In fact he was told that almost certainly not only this but that he will not be entitled to refund of tax but even be required to complete tax in Israel, over and above the tax that he paid abroad. And not only this, it also became clear to him that it is possible that in regard with part of the profits it is even possible that he will be required to pay national and health insurance in Israel, without considering his payments paid for national insurance in the US.
While clarifying the circumstances of of D.I.’s move abroad, it became clear that, due to a lack of knowledge he had made a number of basic errors, which Income Tax based itself in order to contend that the change in residency actually occurred only during the year after the year of relocation. i.e. as an Israeli resident with income from outside Israel, D.I. must pay tax in Israel on his income worldwide. Thus for example, D.I. did not phrase the employment contract and the apartment rental contract correctly. He did not understand the consequences of paying national insurance in Israel and did not correctly plan the dates of his and his wife’s move to the US.
Also in this case, despite the unpleasant situation that he faced, after long and tiring discussions with Income Tax, while clarifying the provisions of the tax treaty and the internal laws in the US, Income Tax agreed to refund the tax. Nevertheless, it is clear that proper tax consulting could have saved D.I. unpleasantness and considerable anguish.
Negative example – The returning resident
M.G – is a former Israeli who after many years of living in the US, decided to return to Israel with his family. In the US he managed to accumulate various assets: Negotiable and non-negotiable shares, savings in banks and various real estate properties. Some of his financial investments he also transferred to Israel.
As a result of the tax reform in Israel, M.G. asked to clarify whether his income and assets that he accumulated in the past in the US are taxable in Israel. In addition, he asked to clarify how his income in the US will be taxable in Israel? Regarding the past – M.G. was satisfied that it became clear that in Israel he is not liable to tax on income and assets that he had accumulated as a foreign resident, even though in the distant past he was an Israeli resident.
Regarding future income, after he will return as an Israeli resident, M.G. was happy to discover that according to Israeli law there are exemptions and tax benefits regarding various income of a returning resident, with certain limitations. Despite the limitations on the exemptions and the benefits, with correct planning it was even possible to extend the validity of the exemptions and even to apply them to assets that will be acquired abroad after M.G. returned to being an Israeli resident. In addition, despite the fact that the income tax exemptions and benefits do no apply regarding national insurance and national health insurance, M.G. was happy to discover that with correct planning it will be also possible to absolutely legally avoid these payments.
There is considerable importance in determining the status of an Israeli resident, a foreign resident, a returning resident or a new immigrant for tax purposes (also with the suitable adjustments regarding a limited liability company). Without careful planning there will be tax consequences as a result, both at the time of the transition from Israeli residency to foreign residency (in order to avoid the heavy tax consequences in Israel on income from abroad) in order to enjoy tax benefits on the transition back from foreign residency to Israeli residency. It is therefore important not neglect this matter without handling it.