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27 February 2014

Taxation of foreign income and the 10-year rule

Since 2003, Israel has joined the rest of the Western world in taxing its residents on their worldwide income.

Israel has also signed a number of Double Taxation Treaties with other countries which set out various rules for which country can tax certain incomes and in what scenarios. The Double Tax Treaties override the local tax law, so you get the best of both worlds.

This post will assume that a Double Tax Treaty is not in force, or that the income is taxable in Israel anyway. Of course, advice should be taken on taxation of the income in the country of origin. Furthermore, this post relates to Income Tax only, and does not consider the Bituach Leumi aspects of earned income, or the equivalent abroad.


Tax on foreign income

In general, income from overseas is treated and taxed in the same way as Israeli income, and the same rules and rates apply. Israeli tax law though allows you to reduce the Israeli taxes due on that income by taking a credit for any foreign taxes paid. (See here for the classic exemption of property income.) Of course, the credit is limited to the lower of foreign taxes actually paid and the Israeli taxes due on that income. Or in simple terms, you'll end up paying the highest rate between the two countries, but never more.

To make things somewhat complicated, the law allows you to claim foreign taxes paid in one country against taxes due on income earned from another country - but only within the same "income basket". For example you can claim UK taxes paid on UK interest against interest earned from all corners of the Earth, but not against foreign dividend or self-employment income.

Another complication is the calculation of the Israeli tax considered due on foreign income. For fixed-rate incomes (e.g. interest, dividends etc.), the fixed rate is applied to the foreign income. That's fairly easy. But for incomes where the tax rates are based on the bands, the calculation gets very complicated, and it's fair to say that someone with both Israeli and foreign types of this income ends up paying significantly more Israeli taxes than had they not had the foreign income at all - even if the foreign income is well in excess of what the Israeli taxes would be. If that sounds complicated and unfair, that's because it is - and there's no remedy under the current legislation.


Exchange rates

Of course, Israeli taxes are based on the shekel values of incomes and overseas taxes paid. The tax law states that each transaction is to be translated at the official Bank of Israel exchange rate.

That's not always practical, and in that situation I would use the average exchange rate, either for the month or the whole year.


The 10-year rule

Anyone who became a new resident of Israel (Oleh Chadash), or is considered a veteran returning resident (lived out of Israel for at least 10 years) from 1st January 2007, is entitled to a 10-year exemption from paying Israeli taxes on non-Israeli income. The 10-year starts on the day that their residency is considered to have changed to Israel, and ends on the 10th anniversary.

The definition of non-Israeli income is crucial here. The tax law defines where different types of income are considered to have been earned. The most important element for this post is that self-employment income is considered earned in the country in which the work is actually done. What that means in practical terms is that anyone working from Israel for a non-Israeli organisation is considered to be earning Israeli income, which is subject to Israeli taxes, even within the ten years.

4 comments:

  1. Do you know if income that is considered non-taxable in the US (disability payments, adoption subsidies) are considered non-taxable in Israel? Thank you!

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  2. The Sarbanes-Oxley Act, also called the Public Company Accounting Reform and Investor Protection Act of 2002 was signed into law on July 30, 2002 by President Bush. In the aftermath of Enron, Arthur Andersen, Global Crossing, and WorldCom, SOX promises greater corporate accountability and transparency. Named after Senator Paul Sarbanes and Representative Michael G. Oxley, SOX focuses on the importance of ethical behavior in corporate governance-across the United States and now…overseas.

    All countries have government-required laws like Sarbanes Oxley. In the UK, it’s the "Combined Code on Corporate Governance," in The Netherlands it’s the "Code Tabaksblatt," Germany has a "Bilanz Reform" and a "Bilanz Kontroll Gesetz." But then, why do we need SOX overseas since we already have the required laws? It’s because companies with U.S. headquarters must ensure that all foreign outposts meet federal standards. This is the major cause of concern in the management and accounting circles. According to some experts, the Sarbanes Oxley Act might have dictated convoluted rules and regulations on the U.S. businesses. While the rules are concrete ideologies that prevent accounting scandals, the constant flux in the policies confuses businesses around the globe.

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  3. Do you have a post about the u.s.-israel tax treaty? Specifcally where capital gains are concerned. It seems that according to the treaty if you have capital gaons on american stock in an american broker you do not need report that income in Israel

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  4. In case of foreign income, there are huge things to be taken care. As the source of income is from outside the country so you need to pay tax for it. Also the task rate changes time to time so there is a problem to keep track of your accounts. If the business size is little big then you'll surely need an accountant/bookkeeper to take care of your accounts. Bookkeeping Services Los Angeles. Just not in Israel but in all countries these issues are there. Thanks for the info, focusing on the tax rate and exchange rates of Israel. It's really helpful for the Israeli businessman. Please provide more info about the 10-years rule.

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