Individuals seeking to invest in Israel ought to be aware of the tax effects of such an endeavor. The following contains a summary of material Israeli tax consequences for individual foreign investors with regard to different types of income usually generated as a result.
General
Israeli taxation is regulated mainly by the Income Tax Ordinance [New Version] 5721-1961 (hereafter: “Israeli Tax Ordinance“).
The first phase in determining the tax consequences regarding an investment by a foreign individual is to define the source of income.
The second phase is to apply the governing framework in a Double Taxation Treaty, if applicable, between Israel and the individual’s country of residence.
As detailed below, the jurisdiction covering the source of income usually has the first right of taxation. While the other jurisdiction may also have the right to tax the income, a tax credit mechanism is applied to determine the relative tax liable in the second jurisdiction.
Therefore, the third phase would be to determine the tax rate for each type of income in Israel, including tax exemptions and credits.
Capital Gains on Shares of an Israeli Company:
- According to Section 89 of the Israeli Tax Ordinance, the place where a capital gain was derived or accrued is Israel, if resulting from a sale of share or the right to a share in an Israel-resident corporation.
- Israeli residents: The income tax rate applicable to capital gains derived by an Israeli individual from the sale of shares (regardless of whether listed on a stock exchange) is 25%. However, if said individual is considered a “substantial shareholder”[1] at the time of sale or at any time during the preceding 12-month period, the applicable tax rate is 30%[2].
- Foreign individuals: According to Section 97(b3) of the Israeli Tax Ordinance, a foreign resident is tax-exempt on the capital gains earned upon the sale of the security of an Israel-resident company, subject to certain conditions: (i) the capital gain is not in the corporation’s permanent enterprise in Israel; (ii) the security was not acquired from a relative; and (iii) at the time of the sale the security is not traded on the stock exchange in Israel.
Dividends to Shareholders of an Israeli Company:
- According to Section 4A of the Israeli Tax Ordinance, dividend payment generated is based on the residency of the corporation paying the dividend, i.e. a dividend from an Israeli company is taxable in Israel.
- Israeli residents: The income tax rate applicable to dividends received by an individual is 25%. If said individual is considered a “substantial shareholder” at the time of distribution or at any time during the preceding 12-month period, the applicable tax rate is 30%[3].
- Foreign individuals: There is no exemption on dividends applicable to foreign individuals. However, if a double-taxation treaty is applicable, a reduced withholding tax rate in the resident jurisdiction may apply;
For example, under the U.S-Israel Tax Treaty with respect to taxes on income, dividends originating from an Israeli company and received by a U.S individual resident, are taxable in both countries, but may not exceed 25%.
Therefore, a U.S individual resident in receipt of a dividend from an Israeli company, may require the U.S Tax Authorities to apply a reduced withholding tax rate of no more than 25%, and be eligible to receive a tax credit for the tax paid in Israel.
Interest on Loans Paid by an Israeli Company:
- According to Section 4A of the Israeli Tax Ordinance, interest is generated based on the residency of the corporation paying the interest, i.e. interest paid by an Israeli company is taxable in Israel.
- Israeli residents: The income tax rate applicable to interest received by an individual is 25% (or 15% if the interest is not related to linkage differentials). If said individual is considered a “substantial shareholder” at the time of payment or at any time during the preceding 12-month period, marginal tax rates would apply, up to 50%.
- Foreign individuals: There is no exemption on interest for foreign individuals. However, if a double taxation treaty is applicable, a tax credit mechanism for the amount paid in jurisdiction of source (i.e. Israel) may apply.
For example, under the U.S-Israel Tax Treaty with respect to taxes on income, interest paid by an Israeli company and received by a U.S individual resident, is taxable in both countries. Israeli taxation would be no more than 17.5% of the interest amount, while the U.S would also have the right to taxation according to its applicable law, while providing a tax credit for the amount paid in Israel.
Surtax:
- An additional tax at a rate of 3% is imposed on high earning individuals whose annual taxable income or gains exceed NIS 651,601 (in 2020).
[1] Anyone who, directly or indirectly, alone or together with another, holds at least 10% of one or more types of control of the corporation, or has the right to nominate members of the board.
[2] Subject to the possibility of imposing a surtax of 3%, as described below.
[3] Subject to the possibility of imposing a surtax of 3%, as described below.
