1.  Artzi, Hiba & Elmekiesse - Tax Solutions Ltd.
The Israeli tax system and tax
benefits for foreign residents
Ran Artzi, CPA (Isr).
May, 2007

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The Israeli tax system

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The Israeli tax system - General
• As of 2003, income Tax in Israel is levied based on
a personal method. Accordingly, Israeli residents
are liable to tax in respect of their income
worldwide.
• Foreign residents are also liable to tax in Israel
with respect to income generated or derived therein
(according to source rules) and subject to
conventions for prevention of double taxation
between Israel and the relevant countries.

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Israeli resident - Individuals
An individual is considered an Israeli resident if his
“center of life” is located therein; in this regard, the
following considerations are observed :
• location of his permanent home (individual &
family members).
• Location of his economic and social connections.
• Location of his permanent or usual employment/
business activity.
• Location of his active and substantive economic
interests.

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Israeli resident - Individuals
The Israeli law sets 2 legal presumptions - an
individual's “center of life” is located in Israel in the
following cases:
 During the tax year he was present in Israel for
183 days or more, or -
 During the tax year he was present in Israel for 30
days or more, and his total presence in Israel during
that year and 2 previous years amounts to 425 days
or more.

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Israeli resident - an Entity
A person other than an individual is considered an
Israeli resident if either one of the following is met:
• It was incorporated in Israel.
• the “control and management” over its business
is exercised within Israel.

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Income tax rates for Individuals

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General
Regular income of individuals is taxed, Current to
2007, at the following rates (applied to annual gross
income):
0 - 133,680 nis - 30%. (31,760$)
133,681 - 192,000 nis - 35%. (31,761$ - 45,616$)
192,001 - 413,400 nis - 36%. (45,617$ - 98,218$)
above 413,401 nis - 48%. (98,219$)

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Gradual decrease of rates
Tax rates will gradually decline until 2010.
marginal rate will be set to 44%.
To this end, overall tax rate is inclusive of social
security and health tax payments.

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Rental income from Israel
• Tax exemption for rental income from apartments
in Israel up to 4,200 nis (1,000 $) per month.
• The income tax liability on apartments rental fees is
calculated on the basis of one of the following
alternatives:
• Rental income is calculated after deduction of
expenses and taxed as business income
(progressive) tax rates - over 30% rate.
• Tax is payable at the rate of 10% of gross rental
income (without deducting expenses).

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Overseas Rental income
The tax liability of an Israeli resident individual with
respect to rental income from real property located
outside of Israel, is determined on the basis of one of
the following:
• progressive tax rates applied to net rental income
(deduction of permissible expenses). FTC is allowed.
• flat rate of 15% on rental fees after deduction of
only depreciation expenses. other expenses incurred
in generating the rental income are not deductible.
FTC is denied.

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Passive Investment Income - flat rates
• Dividend income - 20% or 25% for an individual
who is a “substantial shareholder” (10% or more).
15% - dividend distributed out of the profits of an
“approved enterprise” under law of encouragement.
• Capital gains - 20% or 25% for an individual who is
a “substantial shareholder”.
However, capital gain from assets acquired prior to
1.1.2003 are allocated - on a linear basis -
* part of gain attributed to the period prior to
31.12.02 - general tax rates.
* part attributed thereafter - 20%/25%.
• Interest income - 20% (15% - unlinked assets),
except for a “substantial shareholder”.

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Taxation of Employee Stock Options
Plans - (ESOPs)
• Generally, the income derived from ESOPs may
be taxed as ordinary income.
• Subject to certain conditions, there is a possibility
to grant ESOPs, the gain from which will be taxed
as capital gain to the employee. The employer is
denied the wages expense.
• The tax is levied only when the option or the
proceeds deriving from it are actually transferred
to the employee.

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Personal Credit Points
Israeli resident individual taxpayers are awarded
personal tax credit points that are offset against the
income tax payable. For 2007, each credit point
equals 2,136 nis (509 $) per year.
A taxpayer’s entitlement to credit points generally
depends on personal and family circumstances.
For example:
• A male Israeli resident is awarded 2.25 points.
• A female Israeli resident is awarded 2.75 points

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Income tax rates for Companies

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Corporate tax rates:
• 2007 - 29%.
• 2008 - 27%.
• 2009 - 26%.
• 2010 (and on) - 25%.
• Lower rates may apply under law for
encouragement of capital investments.
• Capital gains: 25%. Assets acquired prior to
1.1.2003 - linear allocation - general tax rate/25%.

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Accumulated Profits
At the sale of shares (including liquidation of a
company), a tax benefit is granted on gains liable to
tax on the corporate level.
• The part of the gain in the amount of the said
profits accrued up to 31.12.2002 is liable to tax at
10% rate.
• Profits accrued after 31.12.2002 is liable to tax at
20% or 25% rate for individuals, and 0% for
companies.

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Losses
• Losses arising from a trade or business may be set
off, in the year in which they arise, against income
from any source.
• the balance of such losses, if any, will be carried
forward, without time limitation, to offset income
from a trade or business, as well as business
capital gains and land appreciation, but not
income from other sources.
• Tax losses cannot be carried backwards.

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Setting-off foreign losses
• Foreign losses are generally set off against foreign
income.
• Passive losses from may set off passive income, and
business or vocation losses may set off likewise
income;
• Exception: excess loss from foreign business of
which control and management are exercised from
Israel, may be set off against income accrued or
derived in Israel that year.
• Capital loss from sale of an asset abroad: shall be set
off first against foreign capital gain.
• Precondition for off setting losses - had it been
income it was subject to tax in Israel.

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Controlled Foreign Corporation (CFC)

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CFC - General
The CFC legislation – Article 75B of ITO - is designed
to prevent the deferment or avoidance of taxes
through the use of foreign corporations, with respect
to passive income.
According to the legislation, an Israeli resident who
has control over a controlled-foreign-corporation, is
subject to tax on his pro-rata portion of that
corporation’s “undistributed profits” as though they
were actually distributed to him as dividends at the
end of tax year - Deemed dividend.

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CFC - A Controlling Member
 The rules set in article 75b apply to an Israeli
resident who is “a controlling member”.
 A controlling member is a person that holds,
directly or indirectly, by himself or jointly, at least
10% of any “means of control” of the corporation at
either one of the relevant dates.

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CFC - definitions
A “controlled foreign corporation” is a Foreign resident
body-of-persons that meets the following:
 Its shares or other interests are not traded on a stock
exchange.
Most of its income or profits during the tax year are passive.
In this regard, a specific rule is set for a corporation held by a
business company.
The tax applied to its passive income overseas does not
exceed 20%.
More than 50% of any of the corporate’s “means of control”
are held, directly or indirectly, by Israeli residents. In this
regard, other alternatives are set by the law.

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CFC - Definitions
“Passive Income” - an income being one of the
following, except if it is of a business nature:
 Interest or linkage differences.
 Dividends.
 Royalties.
 Rental income.
 Consideration for the sale of an asset which was
not used as part as the corporation’s business.

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CFC - Definitions
“Undistributed Profits”:
 Profits originating in passive income of the
company, except for profits originating from
dividends received from another foreign corporation
whose income was taxed at a rate that exceeds 20%,
that were not paid to shareholders during the tax year
The profits are calculated according to domestic tax
laws of the foreign company’s state of residence,
except if it is not a “treaty country“, in which case
the profits will be calculated according to accounting
principles accepted in Israel.

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CFC - prevention of double taxation
Upon actual distribution of the cfc’s profits to its
shareholders, or upon the sale of its shares, tax
previously paid by a shareholder for such
undistributed profits will be credited against tax
due in connection with the distribution or sale,
as the case may be.

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Foreign Vocation Company (FVC)

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Foreign Vocation Company
A foreign body-of-persons that meets all the
following:
 If it is a company, not more than 5 individuals
control the company.
 75% or more of any “means of control” are held,
directly or indirectly, by Israeli resident individuals.
 Most of the controlling members or their
relatives, carry on “a special vocation” on behalf of
the corporation.

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Foreign Vocation Company
 Most of its income or profits derive from “a
special vocation”.
 Income generated by FVC from activities
preformed by a controlling members (through his
relative or a company under his control) shall be
taxed in Israel as income generated in Israel.
 The FVC is considered an Israeli resident for
domestic tax purposes.

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Rules for Foreign Tax Credit (FTC)
• FTC is granted to Israeli residents only with
respect to their income generated outside Israel
(according to Israeli source rules).
• Foreign taxes may offset Israeli tax levied on the
same income, while separating different types of
income - the “basket method”. In this regard, all
income of the same type generated in all countries
except Israel are grouped into one basket (e.g.
dividend basket; business income basket etc.).
• Cross-credit within a basket is permitted.

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Rules for Foreign Tax Credit (FTC)
• No credit is granted for income exempt from tax
in Israel.
• excess foreign tax may be carried forward up to 5
years (within a basket) and will be index-adjusted.

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Exit tax
• An Israeli resident that ceases to be an Israeli
resident is treated as if he sold all of his assets on
the day before he ceased to be an Israeli resident.
• Payment of tax may be postponed until the day on
which the asset is disposed of.
• In case the disposition price is lower than the value
of the asset on the day in which the taxpayer ceases
to be an Israeli resident, the lower value applies.
• The exit tax is not imposed in to assets which
remain subject to Israeli tax.

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Real estate taxation

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Land betterment tax
The Land betterment tax is levied on gain derived
from:
• Sale and any kind of transfer of real estate located in
Israel;
• Disposition of shares or other interests in a “Real
Estate Company” (a body-of-persons whose entire
assets comprise of interests in real estate located in
Israel, except for accessory assets).
• Tax rate for land betterment accrued after 7.11.2001
is 20% for individuals and 25% for companies. For
land betterment accrued before that day - marginal
rates for individuals and companies rate for
companies.

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Land betterment tax
• The sale of a residential apartment by individuals
is exempt from land betterment tax if certain
conditions are fulfilled.
• Exemption from land betterment tax is granted for
certain types of transactions (e.g. a gift between
individual family members).

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Acquisition tax
• Real estate purchased in Israel is subject to
acquisition tax payable by the buyer. Generally, 5%
tax rate is imposed on the value of real estate.
• For a residential apartment, the acquisition tax is
calculated based on purchase price as follows (if
certain conditions have been fulfilled):
• Up to 476,215 nis (113,385 $) - 0.5%.
• From 476,215 nis (113,385 $) until 739,120 nis
(175,980 $) - 3.5%.
• Above 739,120 nis (175,980 $) - 5%.

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Value added tax (vat)

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Value added tax
• Value added tax (Vat) is levied on the consumption
of goods and services in Israel. Vat is indirect tax,
levied goods delivered and services rendered in
Israel.
• The current vat rate in Israel is 15.5% for all taxable
transaction.
Transactions subject to 0% Vat rate (examples):
• Exported goods.
• Sale of intangible assets to non residents.
• Services rendered outside Israel to non resident.

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Social security

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Social security
• Employers, employees and self-employed are liable
for social security payments. The employee’s share
includes compulsory health insurance.
• The social security rates are based on gross monthly
income, as follows (current to 2007):
• Employee’s share: 3.5% for 3,580-4,522 nis (852-
1,076 $) gross income, and 12% for 4,522-35,760
nis (1,076-8,514 $) gross income.
• Employer’s share: 4.14% for 3,580-4,522 nis
(852-1,076 $) gross income, and 5.68% for 4,522-
35,760 nis (1,076-8,514 $) gross income.

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Tax benefits for foreign residents

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general overview
• Israel encourages investments from both Israeli
and foreign residents, by offering a wide range of
incentives and benefits through a number of laws
and regulations.
• In order to promote weak economic regions within
Israel, certain benefits are granted in a differential
manner - greater benefits in “priority regions” (A,
B) than in the center of the country. However,
enterprises throughout the country may be eligible
for benefits if they comply with the relevant
criteria.

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general overview
• Special emphasis is given to high-tech industries
and R&D activities.
• Specific tax benefits are designated for foreign
residents designed mainly to promote investment
in Israeli capital market (including banks).
• Increased tax benefits for companies with greater
“foreign participation” under the Law for
Encouragement of Capital Investment.
• special anti abuse section to prevent “Israelis”
from abusing such benefits - art. 68A.

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Categories of exemptions & benefits
• Exemption from tax on capital gains;
• Exemption from tax on investment income;
• Law for Encouragement of Capital
Investment from 1959;
• Participation Exemption;
• Taxation of Trusts;
• Sec 16A of Income Tax Ordinance.

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Exemption for capital gains
• Gain derived from the sale of securities traded in
Israeli stock exchange, provided the gain was not
derived within a permanent establishment of the
seller located in Israel.
• Gain derived from the sale of Israeli resident
company’s securities traded in a foreign stock
exchange, provided the gain was not derived within
a permanent establishment of the seller located in
Israel, the security was purchased after registration
for trade and other conditions.

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Exemption for capital gains
• Gain derived from the sale of shares in an
Israeli resident company who - at the time
of issuance of such shares - was approved
as an “R & D Company”.

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Special exemption to boost investments -
Art. 97(B3)
Special exemption from CG in relation to investments
in Israeli resident companies (or foreign companies
whose main assets are interests in Israeli assets)
between 1.7.05 and 31.12.08.
The exemption is excluded for:
• Gain derived within a PE of the seller in Israel.
• Gain derived from the sale of any security of a
company which - at the acquisition date of that
security and two years preceding its sale - the major
value of its assets comprised of interests in real estate
located in Israel or in an Israeli real estate company.

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Special exemption to boost investments
Conditions at the acquisition date:
• Acquisition between 1.7.05 - 31.12.08.
• Acquisition for “Fair Value” consideration.
• The purchaser was a resident of a country with
which Israel had a convention for the avoidance of
double taxation (treaty country), as follows:
• An individual purchaser - was a resident of a treaty
country for at least 10 years prior to acquisition;
• A foreign entity purchaser - at least 75% of
“controlling interests” over such entity were held,
directly or indirectly, by individuals who were
residents of a treaty country for at least 10 years
prior to acquisition.

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Special exemption to boost investments
• An acquisition statement was filed with Israeli tax
authority within 30 days of acquisition.
Conditions at the selling date:
• The seller is a resident of a treaty country;
• The seller reported the sale to the tax authorities of
country of which he is a resident.
• The seller filed a request to be exempt from tax to
Israeli tax authorities.
The exemption is not conditioned upon the date of
selling.

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Exemption for interest on a “Foreign-
Currency-Deposit”
• Interest paid to a foreign resident for a non-NIS
deposit in an Israeli bank is exempt, provided all
the following conditions are met:
• The deposit is not within a PE located in Israel and
the income does not derive from business activity.
• No Israeli residents share interests in the deposit.
• “a foreign resident statement” was filed.
• The deposit has not secured a loan granted by the
bank to an Israeli resident, who is a relative of the
owner (a family member or controlled corporate).

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Exemption for income / gain from
government bonds or loans
• Interest (including discount) or index-linkage
differentials paid on a government bond or loan
traded in Israeli stock exchange;
• Capital gain derived from the sale of such
government bond or loan not traded on stock
exchange (in Israel or overseas);
Exempted provided that:
• The tax payer was a foreign resident at the date of
the bond/loan’s acquisition and/or at the date of its
sale.
• The income/gain from the bond/loan are not within
his PE located in Israel.

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Investment income in Israeli capital
market - foreign residents mutual fund
Exemption from tax for a foreign resident mutual
fund:
• CG from sale of securities listed for trade in Israeli
stock exchange, if acquired following listing or from
the sale of foreign securities.
• Interest & currency differentials for foreign-
currency deposit in Israel.
• Dividend, interest & currency differentials derived
from foreign securities.

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Exemption for investment income
• Currency differentials on a loan granted by a
foreign resident, provided that it was not granted
through his PE in Israel.
• currency differentials on a company’s foreign
currency bank deposit originating from a foreign
resident's payment for such company’s shares,
provided the company is mainly controlled by
foreign residents.

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Exemption for interest income
• Interest paid by an Israeli body-of-persons to a
foreign resident in relation to a foreign currency
loan granted by him provided it is used for a
purpose included in the Law for Encouragement
of Capital Investment.
• The exemption from tax (wholly or partly)
requires the approval of the Minister of Finance.

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Article 16A of ITO
The Minister of Finance is authorized to return
income tax, fully or partly, to a foreign resident if the
tax payable in Israel is not granted to his as a credit
against the tax due in his state of residence.

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Investment incentives and trade advantages

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Law for Encouragement of capital
investments, 1959 (“the law”)
• A special status of an “approved enterprise” or
“program” may be awarded to investments
(domestic and foreign) and activities (mainly
industrial) in Israel.
• This status awards income tax benefits (current
business income & dividend distributed) and/or
government grants.
• The law applies to industrial enterprises (including
high-tech and bio-tech), hotels and other tourist
ventures, industrial and residential buildings. It may
also apply to industrial development centers located
in Israel.

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Encouragement of capital investments
In recent years, the law has undergone comprehensive
amendments. Presently, 3 “routes” of tax benefits are
available to enterprises located in preferred region A:
• A scheme allowing tax exemptions during the
concession period.
• The company tax is, wholly or partially, deferred
until distribution of untaxed profits, at which time it
will be paid by the company.
• Lower withholding tax rate in respect of dividends
distributed - 15%, or lower according to a tax treaty.

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Encouragement of capital investments
The scheme known as the “Ireland Scheme” -
• The profits are taxed at the rate of 11.5%.
• No additional company tax is required when profits
are distributed.
• Withholding tax rate in respect of the dividends
distributed from such profits - 15% for Israeli
residents shareholders and 4% for foreign residents.

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Encouragement of capital investments
A strategic investments scheme -
• The enterprise is granted a full tax exemption
during the concession period and is not required to
pay additional tax upon distribution of profits as
dividends.
• No tax withholding from dividends.
• A minimum threshold of investment amount -
between 147$ - 220$US million (depending on
location).

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The approval requirement
• An enterprise seeking grants is required to submit a
plan to the Investments Center.
• An enterprise wishing to benefit from tax
concessions is no longer required to file a formal
request. Provided it complies with the conditions
stipulated by the law, it is eligible for such tax
benefits and may claim them under the income tax
returns it files.

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General requirements
• Under the grants scheme, the enterprise is
required to fund 30% of the scope of approved
investments in equity.
• No such requirement exists for the tax benefits
schemes.
• For investors defined as “foreign residents”, the
state provides increased tax benefits which they
are able to enjoy for longer periods.

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Tax benefits period for grants scheme
Tax benefits for an approved enterprise are granted
for a period of 7 consecutive years and may be
extended, under certain conditions, up to 10 years for
foreign invested companies.

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Approved enterprise controlled by foreign residents
The reduced tax rates are in accordance with the
percentage of foreign participation, as follows:
(1) 15% of the balance for approved enterprise, 25% otherwise.
Taxes may differ for residents of countries that have tax treaties with
Israel.
Not an
approved
enterprise
An approved enterprise - % of
foreign participation
0-49 49-74 74-89 90-100
Taxable income 100 100 100 100 100
Corporate tax 29 25 20 15 10
Balance 71 75 80 85 90
Tax on distributed
dividends
17.75 11.25 12 12.75 13.5
Total tax burden 46.75 36.25 32 27.75 23.5

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“A foreign-invested company”
In order to be consider as an “approved enterprise
controlled by foreign residents”, certain conditions
have to be fulfilled:
• the foreign residents must invest at least 5 million
NIS (1.2 million $) in the company’s capital stock,
including shareholder loans, such investment
providing a right to its capital stock, profits, voting
power and managers nomination.
• Foreign resident who purchased a company whose
paid-up capital stock exceeds 5 million NIS.

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“A foreign-invested company”
A company controlled by an Israeli resident,
directly or indirectly, or a company that Israeli
residents are eligible to 25% of its profits, will not
be considered as an enterprise controlled by
foreign residents.

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Tax benefits for “exempt enterprise”
(non-grants scheme)
• The enterprise must be an industrial plant or hotel.
• The Enterprise is competitive and contributes to the
gross domestic product. (An enterprise will be
considered to have fulfilled this condition, for
example, if it is engaged in bio technology or
nanotechnology and has obtained the approval of the
head of industrial R&D administration, or if it exports
at least 25% of his yearly income).
• Minimum investment in capital assets/equipment,
as described below.

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The minimal amount of investment
• New investment - at least 300,000 nis (71,430 $).
• Expansion of an existing enterprise - a percentage of
the value of productive assets, as follows:
 Up to 140 million nis (3.33 million $) - 12%.
 Above 140 million nis (3.33 million $) and up to
500 million nis (119 million $) - 7%.
 Above 500 million nis (119 million $) - 5%.
Provided that the total amount of investment will not
be less than 300,000 nis.

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Tax exemption (deferral) until profit
distribution
A company may choose an alternative benefit scheme
allowing it tax exemptions instead of grants. Only limited
liability companies are entitled to choose this scheme.
This periods for tax benefits are as follows (years):
(1) On the undistributed portion only.
(2) The reduced tax rates are identical to the rates details above.
National priority region
A B C
Tax
exemption
(1)
Reduced
taxes
(2)
Tax
exemption
(1)
Reduced
taxes
(2)
Tax
exemption
(1)
Reduced
taxes
(2)
Domestic
company
10 - 6 1 2 5
Over 25% foreign
control
10 - 6 4 2 8

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Tax exemptions until profit distribution
• Companies in which foreign participation exceeds
74%,(and with approved program not less 20 million
$) are entitled to a longer benefit period (15 years),
subject to the approval of the investment center
board.
•The tax exemption is actually a tax deferment. The
exempted tax becomes due when the enterprise
distributes tax exempted profits.

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Accelerated depreciation
Approved enterprises are eligible for accelerated
depreciation on the tangible assets, reaching 400%
of standard depreciation rates on buildings (not
exceeding 20% per annum and exclusive of land),
and 200% on equipment. The tax authorities may
allow increased rates of up to 250%, if there is
evidence of a high depreciation rate of equipment.
This benefit is available for a 5 tears period from
date of operation rather than from purchase date of
asset.

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Participation exemption

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Participation Exemption
• A recent legislation (in force as of 1.1.2006)
provides for a participation exemption regime for
Israeli holding companies, under specific
conditions.
• An Israeli holding company is exempted from tax
on the following:
(1) dividends received from foreign subsidiaries;
(2) capital gains tax upon sale of such subsidiaries;
(3) interest on bank deposits in Israel and on income
(interest, dividends, and capital gains) from
securities traded in Israeli stock exchange.

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Participation Exemption - benefits for
foreign investors
• Foreign shareholders benefit from a reduced
withholding rate on dividends distributed by the
Israeli holding company - 5%.
• Foreign shareholders may apply for tax
exemption on capital gain upon the sale of the
Israeli holding company’s share under Art. 97(B3)
- special exemption.

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Participation Exemption
Israeli
residen
t
Foreign
resident
Israeli holding company

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Participation exemption
Definitions: “Israeli holding company”
• Registers in Israel, Managed and control from Israel.
• The company is privately owned and not tax
transparent.
• The company is not a financial institution.
• Its total investment in foreign subsidiaries,
throughout at least 300 days of the tax year,
amounts to at least 50 million NIS(11.9 million $).
• 75% or more of its assets constitute the subsidiaries.
• The company formally requests to be recognized as
a holding company.

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Participation exemption
“Subsidiary” for participation exemption:
• Resident of a treaty country.
• Resident in non treaty country - provided that the
corporate tax rate on business income in that country
is 15% or more (at time the shares are purchased).
• The Israeli holding company holds at least 10% of
profit rights in the subsidiary for 12 consecutive
months.
• At least 75% of the subsidiary’s income from
sources outside Israel business income.
• Israeli assets or Israeli income of the subsidiary may
not comprise more than 20% of the subsidiary’s total
assets/income, respectively.

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Taxation of Trusts

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Foreign Resident - Settlor trust
The “Foreign Resident Settlor Trust” classified as
such under recent legislation (in force as of 1.1.2006),
may be used as an instrument for international tax
planning.
A trust is considered a “Foreign resident settlor trust”
if -
• at the time of its establishment, and during the
relevant tax year, all its settlors are foreign residents
(irrespective of the beneficiaries’ tax residency); Or-
• during the relevant tax year, all its settlors and
beneficiaries are foreign residents.
• irrevocable or not.

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Foreign Resident Settlor trust
• The transfer of assets by the settlor to the trustee is
not taxable;
• The trustee’s income is taxable as if it were the
foreign resident's income.
• Income generated outside Israel is not taxable nor
does it need to be reported in Israel.
• Transfer of assets from the trustee to the
beneficiaries is regarded as being transferred to
them by the settlor directly.

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Foreign Resident Beneficiary Trust
“Foreign resident Beneficiary trust” -
• At least one of its settlors, at the time it was
established, was an Israeli residents;
• The trust is irrevocable;
• All the beneficiary during the relevant tax year are
identified foreign residents.

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Tax treaties

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Treaties for prevention of double taxation
• Israel has entered into tax treaties with 42
countries, most of them are based on the OECD
model convention.
• In addition, two treaties have been ratified and
will enter into force as of January 1, 2008.

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