The State of Israel taxes individual residents on a personal basis as per the taxpayer’s venue of his or her centre of life. Once tax residency is determined, Israeli tax residents are taxed on their worldwide income. In contrast, non-Israeli tax residents are taxed only on their Israeli-sourced income.
Following are the applicable Israel tax rates applying to individual taxpayers.
New immigrants to Israel, as well as individuals who return to live in Israel after having lived continuously outside Israel for at least ten years, are only subject to income and capital gains taxes on their Israeli-sourced income during the first ten years of living in Israel. After the expiry of the said ten -year period, such persons continue to enjoy a reduced rate for capital gains tax, computed on a linear basis according to the period of time elapsed before and after the expiry of the ten-year exemption. They are also exempt for those first ten years from reporting to the Israeli tax authorities their tax-exempted foreign-source income (including business income, salaries, dividends, interest, rent, royalties and pensions generated by assets and/or activities held or conducted overseas, regardless of whether acquired or started before or after becoming an Israeli tax resident). New immigrants also benefit from a reduced purchase tax on real estate purchases.
This 'new immigrant' regime exempting from taxation and reporting makes Israel a worthy jurisdiction to consider by wealthy foreign tax residents wishing to relocate as part of their foreign income tax planning. This attraction is enhanced by the fact that Israel is a party to numerous double taxation treaties, with as many as 57 countries and additional tax protocols; the combination of the ten-year exemption plus a tax treaty with the person’s original home country creates a unique planning opportunity.
As of this date, there are no estate, inheritance and generation-skipping taxes in Israel. In fact, a transfer of any asset by way of inheritance, including by will, is not a tax event in Israel. Moreover, except for real estate transfers, currently there is also no gift tax on bona fide gifts, provided the donee is an Israeli tax resident. Real estate gifts are only subject to a fraction of the ordinary purchase tax.
As for trusts (including foundations), a trust is subject to Israeli taxation and reporting obligations if it has at least one Israeli tax resident settlor or beneficiary, or has an Israeli asset.
Similar to the taxation of individuals, an Israeli tax resident trust is liable to tax on its worldwide income, whereas a non-Israeli tax resident trust (ie, a trust that has no Israeli tax resident settlor and/or Israeli tax resident beneficiaries, and never had any Israeli tax resident beneficiary) is only subject to tax on its Israeli-sourced income.
Following are the applicable tax regimes applying to trusts.
Israel did have an estate tax regime until 1 April 1981, when it was abolished altogether. Currently, there are no official proposals to re-enact an estate tax regime. However, levying an inheritance tax has sometimes been a campaign promise in Israeli national elections, as recently as before the 2015 national elections, but no legislative changes have actually taken place.
Israel has implemented the Common Reporting Standard (CRS) and Foreign Account Tax Compliance Act (FATCA) regimes in February 2019 and August 2016, respectively. As a result, Israel automatically exchanges information on an annual basis with the USA, Australia, the UK, Switzerland, Canada and over 90 additional countries. In fact, the recently enacted CRS regulations impose a retroactive reporting obligation, resulting in 2017 bank accounts to be reported no later than June 2019, and 2018 accounts to be reported no later than September 2019.
Hence, Israeli tax residents who have held or still hold bank accounts or other financial accounts and assets in foreign countries, as well as foreign tax residents who have held or still hold bank accounts or other financial accounts and assets in Israel, are exposed to exchange of information between Israel and their home countries, and are strongly advised to settle any potential tax issues with both the Israeli and the foreign tax authorities, including through the current anonymous voluntary discovery procedure offered by the Israel Tax Authority (ITA), available until 31 December 2019.
Israel is a relatively young country, existing just over 70 years. Hence, wealthy families in general, and multi-generational wealth transfers in particular, do not play a major role in the country’s economic reality.
In general, older first generations of means prefer to transfer their wealth to their children by way of a straightforward inheritance, due to their mistrust in the financial and legal systems that have resulted from years of nomadism and exclusion of the Jewish people.
However, as Israel sees a rapid growth of high individual wealth, as a result of large-scale sales of companies and businesses to global corporations, especially in the hi-tech industry, younger first generations of means, with young children or in their second marriage, tend to prefer setting up trusts for the regulation of wealth transfers and for the protection of their children. These trusts, although discretionary and irrevocable, are often set up for a limited period of time, until the child has reached maturity and is able to cope with large amounts of funds.
The Israeli Inheritance Law, 5725 – 1965 contains some important rules on international private laws aspects, including the provisions that (i) Israeli courts have jurisdiction to deal with the inheritance of any person who was a resident of Israel at the time of his death, or whose estate includes assets situated in Israel; (ii) the succession rules that will be applied by the courts are those in force in the country of residence of the deceased at the time of his death; however, when a will is to be examined, the person's capacity to testate is governed by the laws of his country of residence at the time the will was made; and (iii) as to the requirements for certain form and formal features of a valid will, Israeli law is flexible and it recognises the validity of the will if the formal requirements of any of the following countries are met: Israel, the country where the will was made, or the country of residence or usual abode or citizenship of the deceased either upon his death or when the will was made, and, when real estate is involved, the country where the real estate is situated.
Families putting in place succession plans using trusts or similar vehicles should be aware of the complex and strict taxation rules of trusts in Israel, which, inter alia, subject the trust’s worldwide income to full Israeli taxation in the event that there is even one Israeli tax resident beneficiary. Such taxation exists even where the trust’s settlor has not been an Israeli tax resident ever since the settlement of the trust, or has passed away, regardless of the settlor’s tax residency, the situs of the trust’s assets, the trust’s revocability, the number of foreign beneficiaries and the beneficiaries’ right to claim a distribution.
Also, as in most European jurisdictions, families with US persons, companies with US shareholders and trusts with US beneficiaries encounter various difficulties in opening bank and financial accounts in Israel, and sometimes even in conducting ordinary bank transactions such as sending or receiving transfers of funds.
There are no forced heirship laws in Israel.
In the absence of a valid will, the following default heirship rules apply:
Under Israeli legislation, each spouse is free to transfer, during his or her life and upon death, without restrictions, all his or her property, which includes any and all prenuptial property, any and all of his or her postnuptial property inherited or received as a gift, as well as his or her part of the marital property acquired together with the spouse during the marriage.
Nevertheless, if there is an evident contribution by one spouse to the other spouse’s property, the courts tend to regard the assets as joint property, as if it had been acquired together and owned jointly with the spouse during marriage. For example, a wife can claim 50% of her husband's prenuptial apartment, if she can prove that she contributed to the purchase of the apartment by having paid a certain percentage of a loan taken to finance the purchase of the apartment, and/or by having paid for the apartment’s renovation or maintenance.
Thus, in order to insure the protection of assets in wealthy Israeli families, it is quite common for couples getting married to enter into prenuptial agreements, although sometimes these agreements are entered into postnuptial; the Israeli Property Relations Between Spouses Law, 5733 – 1973 recognises the validity and enforceability of such agreements, as long as certain procedural requirements are adhered to.
The Property Relations Between Spouses Law
This law regulates the two different cases of property status of spouses: those having a property agreement (either prenuptial or postnuptial) and those who do not.
For spouses who do not enter into an agreement, the principle adopted by the law is that of 'property equalisation'. In essence this principle means that while the mere existence of marriage does not change the status of ownership of properties and the liability to obligations by each spouse, upon termination of the marriage, due to death of one of the spouses or separation, each spouse becomes entitled to 50% of the value of the spouses’ entire property (including future pension rights, retirement compensation, study funds, pension funds and other savings), with the exception of (i) properties owned by a spouse prior to the marriage, (ii) properties gifted to or inherited by a spouse during the marriage and (iii) payments paid to a spouse by the Israeli National Insurance Agency or in accordance with any law relating to compensation for corporal damage or death. As long as the marriage has not terminated, due to death of one of the spouses or separation, a spouse’s right to property equalisation cannot be transferred, mortgaged or foreclosed.
For spouses who do enter into a property agreement, the law allows freedom of contract. However, in order for such an agreement to be valid and enforceable, the agreement (and any change thereof) ought to be approved by the competent court, after the court has been convinced that both spouses entered into the agreement out of their free will and that they understand its meaning and implications. In the case of a prenuptial agreement, a notary may replace the court, if the spouses so wish, and if executed during the marriage ceremony, the marrying person, if authorised to do so, can approve the agreement.
Property transferred as a tax-free gift among individuals, or upon inheritance, will retain its original cost basis for purposes of future sale as well as for purposes of depreciation. It is possible to request a pre-ruling from the Israeli tax authorities for a step-up of the original cost, when an Israeli tax resident receives (whether as a gift or inheritance) a property from abroad.
The major vehicles for transferring assets within an Israeli family are gifts, inheritance and trusts. Sometimes, a combination of these tools is used. For example, a will can provide for the creation of a trust under its terms, certain shares in a family holding company can be gifted during the lifetime of the donor, while others can be transferred into a trust for the benefit of future generations, and children can be included as co-owners of family bank accounts. Unless the younger generation are not Israeli tax residents, taxes are not a factor in choosing the most suitable mechanism, as there are no gift, estate or generation-skipping taxes in Israel.
Israel has not legally addressed the issue of digital assets inheritance.
Thus, it is being claimed that the Israeli Inheritance Law, 5725 – 1965 does not apply to digital assets lacking real monetary value such as email accounts, unless specifically addressed in a valid will. Hence, if a deceased has not left a will, or has left a will without mentioning his or her digital assets, it is questionable if they will be subject to or affected by an order of probate.
In 2012, in the case of Schwartzman v Psagot Pension Funds, the Tel Aviv District Court recognised that the ownership right of the deceased’s heirs override the deceased’s right to privacy. It is therefore considered that the courts would most likely uphold the heirs’ rights to receive control over digital assets, if such case would be brought to the courts’ decision.
Thus, in practice, most Israeli communication companies allow the heirs access to the deceased’s email accounts, subject to their internal procedures.
As for cryptocurrency assets, the Lod District Court in the case of Kopel v Rehovot Income Tax Assessor recognised Bitcoin as a financial asset, subject to capital gains tax on profits derived from its sale. Hence, the Israeli Inheritance Law should apply in regard to cryptocurrency, as to any other valuable asset.
Israel, being a common law country based upon the English law system, recognises the validity of trusts and foundations.
Israel’s Trust Law, 5739 – 1979 'Israeli Trust Law', which is the main law regulating trusts, recognises four main types of trusts: a private trust, a private trust dedicated by a deed or a will in favour of one or more third-party beneficiaries (also known as a 'hekdesh'), a testamentary trust and a charitable trust called a 'public hekdesh'.
For estate planning purposes, Israelis tend to use either a private trust for the benefit of third parties – a hekdesh – or a testamentary trust regulated by Israel’s Trust Law. Nonetheless, due to the fact that the legal structures available under Israel’s Trust Law are insufficient, under-developed and under-protected from creditors' and beneficiaries’ claims, wealthy Israeli families prefer to use foreign common law trust structures to ensure assets protection.
Israel’s Trust Law legally recognises and regulates the establishment and administration of trusts, whereas the Israeli Income Tax Ordinance (New Version), 5721 – 1961 (Israeli Income Tax Ordinance) regulates the taxation of trusts, including foundations and establishments under foreign laws.
While a trustee’s tax residency is irrelevant to the question of a trust’s taxation under the Israeli Income Tax Ordinance, the location of tax residency of each of the trust’s beneficiaries and settlors is crucial. Even one Israeli tax resident beneficiary is sufficient for levying Israeli taxes on the trust’s worldwide income, unrelated to other foreign laws that may govern the establishment and taxation of same trust. Furthermore, in the event that a trust’s settlor, who is an Israeli tax resident, serves also as the trustee and/or the protector of same trust, the trust shall be deemed a revocable trust for purpose of the Israeli Income Tax Ordinance and shall thus be subject to full Israeli taxation, even if all its beneficiaries are foreign tax residents.
The Israeli legislator has not taken any steps to amend the Israeli Trust Law and/or the Israeli Income Tax Ordinance to allow settlors to retain extensive powers. In fact, in a trust dedicated in favour of a beneficiary (ie, a private hekdesh), unless the trust deed specifically permits changes to be made by the settlor (resulting in the trust being deemed revocable for tax purposes), a change can be made only if all beneficiaries have consented, or a court order has been issued.
Israeli businesses' main asset protection method is the use of corporate shield; namely, limited companies and limited partnerships, which protect the shareholders/limited partners from the risks involved with the underlying business.
Protecting the ownership of businesses from creditors risks is usually achieved through the use of irrevocable and discretionary trusts. In the event that the owner of the business is reluctant to hand over control to an independent trustee, it is common to use offshore holding structures that make it difficult (although not impossible) for creditors to track and locate the assets and link them to the ultimate owner.
As Israel has no estate taxes, inheritance taxes, or even a gift tax (other than a partial purchase tax in regard to gifts of real estate), straightforward gifts are the most common means of transfer of wealth and control to younger generations. Second in popularity would be to transfer only upon death, by way of a well-planned and structured will. Many wealthy families use a combination of both methods, thus allowing training as shareholders to the younger generation, while maintaining the control of the family business with the older and more experienced generation. As an intermediate step, some families choose to separate voting rights from property rights, thus bestowing wealth in the hands of the younger generation without burdening them with the responsibility of managing a business, with an aim to pass on control and responsibility at a later point in time.
More sophisticated families use trusts as a means for executing a measured and regulated transfer of wealth and control to younger generations. Sometimes a trust is combined with strategies originating in the Israeli Companies Law, 5759 – 1999: mainly, the transferring owners would create a holding entity (company or partnership) distinguishing between property rights and control rights; while the property rights are settled into a trust, the controlling interests are either left with the transferring owners or granted to the more suitable next generation member(s), thus retaining equality in the property rights.
Property transferred as a tax-free gift among individuals, or upon inheritance, retains its original tax cost basis for purposes of future sale as well as for purposes of depreciation. However, in the event that an Israeli tax resident receives (whether as a gift or inheritance) a property from abroad, a pre-ruling can be requested from the Israeli tax authorities allowing for a step-up of the original cost to the fair market value of the property transferred. The Israeli tax authorities would most likely impose certain conditions on the set-up, including by limiting the set-off of depreciation, losses, and foreign gifts and inheritance taxes.
Being a relatively young country, the Israeli judicial system does not see a great number of substantial wealth disputes (other than in the case of divorce proceedings). There are hardly any known disputes regarding trusts, foundations, or similar entities, conducted under Israeli law in Israeli courts.
More common are disputes relating to the validity of wills: wills made at old age or by an unhealthy testator are sometimes attacked as being staged by interested parties while not representing the testator's true will due to his or her unsound mind at such time, or as being affected by undue influence.
The Israeli Inheritance Law, 5725 – 1965 is very strict in providing that any provision of a will that benefits a party who has been a witness to, or has participated in any way in the making of, such will is null; hence, this provision of law is used as grounds to abundant disputes aiming to disqualify a will.
Under Israeli Trust Law, if damage is caused to assets or beneficiaries of a trust as a result of an act, omission, or negligence of a trustee, the trustee is personally liable to monetarily compensate for the decrease in value of an asset, as well as for any lost profit (in the amount equalling the difference between the value of the asset at the day of compensation and the value of the asset had the trustee not breached his or her duty).
While Israeli law does recognise the concept of a trust, trusts are not recognised in Israel as a separate legal entity, and all rights and liabilities of the trust rest with its trustee or trustees.
As a trust is not recognised as a separate legal entity, it is common practice to use either a corporate trustee or a 'trust holding company', a designated legal entity fully owned by the trust and acting on behalf of the trustee to hold all or some of the trust’s assets. This structure operates to facilitate the administration of the trust and its assets and activities, and to protect the trustee’s personal assets from blending into the trust.
In Israel, a trustee is personally liable for any damage caused to the trust’s assets and/or beneficiaries as a result of a breach of his or her duty as trustee. Hence, a trustee that acted as per the trust’s terms shall normally not be personally liable if he or she acted in good faith and diligence as a reasonable person would have acted under the same circumstances.
The trust’s terms cannot discharge a trustee from liability, including from the obligation to act in good faith and diligence as a reasonable person, nor provide for an exemption from liability due to negligence. However, a trustee may request the court to exempt him or her from liability, provided that (i) the trustee acted in good faith, and (ii) in performing his or her act or omission, the trustee had meant to fulfil his or her rule as trustee.
As the trustee’s liability for damages means that the trustee is personally liable to compensate for the damages caused to the trust’s assets and/or to the beneficiaries as a result of a breach of his or her duty as trustee, it is highly recommended to insure the risks associated with the activity of trustees.
The aforesaid provisions of the Israeli Trust Law are obviously very conservative and under-developed, and pose significant exposures and risks to trustees acting under it. Therefore, more sophisticated trusts use other legal systems as the governing law of the trust.
The Trust Law requires a trustee to efficiently invest funds that are not required for the daily needs of the trust, thus to preserve the capital and to produce income to the trust. 'Efficiently invest' is interpreted as investing in a manner that does not entail unnecessary risk, allows quick realisation if and when funds are required by the trust, and ensures at least either monetary income or an increase in the investment’s value; all while using the reasonable person test as a scale. Nonetheless, if the trust’s terms specifically state how funds should be invested, the trustee is required to act accordingly.
The Israeli investment standard relies upon the 'reasonable person' test. As a result, and unless the terms of the trust state otherwise, diversification is customary in the industry as it is the diligent act to be done by a reasonable person.
Acquiring or holding an active business does not only contain an intrinsic risk, but also does not necessarily allow for a quick realisation when funds are required by the trust. Thus, holding an active business is not a common practice for a trustee in Israel, although technically being permitted. In fact, where a trust has originally been created with a purpose to hold an active business and ensure its smooth succession, the trustee would not be at risk of being blamed for acting in a breach of his duties. In such cases it is strongly recommended to specifically state this purpose of the trust in the trust deed.
The Law of Return, 5710 – 1950 grants every Jewish person the right to immigrate to Israel and to become (if he or she wishes to) an Israeli citizen. In this respect, a 'Jew' means a person who was born to a Jewish mother, or has converted to Judaism and is not a member of another religion, including a child and the grandchild of a Jew, the spouse of a child of a Jew and the spouse of the grandchild of a Jew, but excluding any person who (i) had been a Jew and had voluntarily converted his or her religion, (ii) had been engaged in an activity against the Jewish people, (iii) may endanger the public health in Israel or the security of the State of Israel, or (iv) has a criminal record, likely to endanger public welfare in Israel.
A non-Jew adult may acquire Israeli citizenship by naturalisation subject to a number of requirements, all being at the discretion of the Israeli Minister of the Interior, including: (i) he or she has resided in Israel for at least three years out of the five preceding years, and (ii) he or she has legally settled in Israel. It may be also required that the person's prior nationality be renounced.
A Jew eligible to citizenship is also eligible to permanent residency. A non-Jew may apply for residency (temporary or permanent) under certain circumstances, which is a fairly long process, imposing different requirements.
Israeli law does not recognise the concept of domicile.
Israeli citizenship of a Jew becomes effective on the later of (i) the day of arrival into Israel, and (ii) receipt of a new immigrant’s certificate. However, a Jewish person may declare, within three months, that he or she does not wish to become a citizen.
There are no expeditious means for a non-Jew individual to obtain citizenship.
Although the Israeli Trust Law does not specifically provide for a special needs trust, such a trust can indeed be set up. It is customary to define in such a trust the standard of care to be granted to the disabled person as well as the means for the treatment of the disabled person, including his or her right to use family assets such as family homes.
Any adult person can prepare oneself for the unfortunate event he or she may become disabled, by signing a Durable Power of Attorney appointing one or more agents to act on his or her behalf in financial, medical and personal affairs when said person shall no longer be able to make decisions and act in such matters. The Durable Power of Attorney may include explicit instructions as to the extent of authority of each agent and the standard of care the person wishes to receive, as well as other preliminary instructions. Unless instructed otherwise in the Durable Power of Attorney, in implementing the Durable Power of Attorney the mandatory supervision of the Government Administrator General is not required.
A request for guardianship should be submitted to a competent court by a spouse, parent, or any other family member of the ward, or by the Israeli Attorney General.
Upon receiving a guardianship request, the court will examine whether a Durable Power of Attorney, instructions for the appointment of a guardian, or any other expression of wish, have been prepared or registered by the intended ward in any registry. If a Durable Power of Attorney has been granted then consent is needed from the appointed person for this appointment, and if there are instructions for the appointment of a guardian, or any other document expressing a relevant wish, the guardian mentioned in those documents should be included in the process as well.
As of the date of appointment, the guardian is subject to the Administrator General’s supervision. However, each of the following requires prior approval of the competent court:
The ageing of the Israeli population was defined as a national, social and financial challenge by the Israeli government in 2015.
As part of addressing the challenge, the Israeli government has enforced a gradual mandatory pension provision (which includes a severance pay component), to be paid by all employers and employees from their monthly salaries. Currently, the mandatory contribution is 6% by the employee and 12.5% by the employer. It is also customary for employers to offer study fund savings to their employees.
In addition, the Israeli government issues each Israeli resident who has reached the retiring age (currently, 62 for women and 67 for men) a Senior Citizen status and certificate granting discounts in public transportation, museums and cultural centres, public parks, bank fees, municipal property taxes (up to a 25% discount, and subject to certain conditions) and other benefits.
In parallel, in order to ensure that every elderly person shall receive a minimal financial support during his or her later years, the National Insurance Agency provides, under certain conditions, old age pension annuity, welfare annuity and income annuity.
Further, Israeli tax laws provide to elderly or retired people reduced income tax rates for certain amounts of income from designated sources such as financial income, pension income and more.
Children born out of wedlock, legally adopted children and legally recognised surrogate children are all considered as legal issue of the deceased parent and grandparent, and are thus eligible to inherit, subject to the terms and conditions of the Inheritance Law, 5725 – 1965. In fact, a child born up to 300 days after the deceased has died is eligible to inherit him or her also if born out of wedlock, adopted, surrogate, or otherwise.
It must be noted, however, that under Jewish law, which is to a large extent controlling legal marriages of Jewish people in Israel as it is adopted by the country’s civil law, a child born out of a married Jewish woman's adultery, although legally considered the child of his biological father (and thus entitled to inherit him), will be defined as a 'mamzer', meaning the child and his or her issue (up to ten generations onward) would not be able to legally marry in Israel. Because of these severe impediments, Israeli courts have taken the position that the paternity of a child born out of marriage cannot be easily legally challenged, in order to avoid creating a body of evidence that might be used to declare the child a mamzer.
Surrogate Pregnancy Arrangements
Israel permits surrogate pregnancy arrangements only for infertile heterosexual couples and single women, provided, inter alia, that (i) all parties are Israeli residents; (ii) the surrogate is an unmarried woman, meaning single, widowed, or divorced, who already has a child of her own (although certain exemptions apply), is above the age of 22 but younger than 39; and (iii) the surrogate is not related to either of the designated parents. It is also required that the designated parents and the surrogate be of the same religion, to ensure that the child’s religious status would be clear (although certain exemptions apply in the case of non-Jewish couples). As a condition to the surrogate pregnancy procedure to take place, the designated parents and the surrogate must sign a surrogate pregnancy agreement, which ought to be pre-approved by an Israeli government committee.
It should be noted that surrogacy is not legal in Israel for convenience or career considerations, but only due to infertility or health reasons.
Same-sex marriage is not legal in Israel, although the Israeli Ministry of the Interior registers same-sex marriages performed abroad in the Israeli population registration.
Many same-sex couples choose not to marry, but rather choose to enter into common law relationships (through contractual marriage), thus providing them with equal access to many of the rights of married couples.
As is customary worldwide, the Israeli Income Tax Ordinance provides for a tax deduction for charitable donations to an Israeli not-for-profit organisation recognised under Section 46 of the Israeli Income Tax Ordinance, provided the donation does not exceed the lower of (i) ILS9,322,000 and (ii) 30% of the donor’s chargeable income for the same year.
In addition, the income of a not-for-profit organisation that has at least seven unrelated members, acting in the areas of religion, culture, education, science, health, welfare, sports, or encouragement of populating rural areas, is exempted from income tax and value-added tax (VAT), provided that its income does not constitute business income.
There are four legally recognised structures for charitable planning in Israel: an 'amutah' (a traditional not-for-profit organisation), a charitable company (a non-profit organisation registered as an Israeli corporation), a public 'hekdesh' (similar to a charitable trust) and a charitable fund (a not-for-profit Israeli corporation aimed at providing grants). All are regulated by the Israeli Registrar of Associations – Non-Profit Organisations, and are subject to the same taxation regulations and to an extensive filing and audits regime. In addition, all four structures cannot distribute any profits, directly or indirectly, to their members/shareholders/trustees, including their founders/settlors.
Thus, the actual structure of incorporation depends upon the selected source of law governing the creation of the structure, namely: (i) an amutah has a separate legal personality and is governed by the Amutot Law, 5740 – 1980; (ii) a charitable company has a separate legal personality similarly to a corporation and is governed by the Companies Law, 5759 – 1999; (iii) a public hekdesh, which is a form of charitable trust, does not have a separate legal personality and is governed by the Israeli Trust Law; and (iv) a charitable fund has a separate legal personality as a corporation and is governed by the Companies Law, 5759 – 1999.
In fact, sophisticated donors usually prefer to incorporate a charitable company or charitable fund, as both of these structures provide more flexibility in terms of ability to retain control and allow for the use of up-to-date solutions. However, if the not-for-profit organisation is intended to include many members of the public, it is recommended to use an amutah, which is easier to manage with a large number of members and benefits from a better public image (although for no good reason).
Nonetheless, as all said structures require extensive reporting and are subject to extensive scrutiny by the Registrar and the public, a donor that only wishes to provide grants to other not-for-profit organisations may wish to refrain from incorporating or forming any charitable structure while he is alive, and to set up a testamentary charitable trust (ie, a public hekdesh) in his or her will.
Developments in Israeli Tax Law Following Israel's Ratification of the MLI
General Background - The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI)
The MLI is a consequence of Action 15 of the Base Erosion and Profit Shifting project (BEPS). The BEPS project was initiated by the G20 to provide recommendations on how to reduce issues of base erosion and profit shifting, mainly by multinational companies shifting their income to jurisdictions with low tax rates. Action 15 suggested a multilateral instrument that would amend existing treaties in order to reduce the opportunities for tax avoidance by multinational enterprises, as well as ensure that the results of the BEPS project be included in the existing tax treaties in a timely manner.
The MLI contains certain minimum standard provisions to be applied with respect to all MLI-participating jurisdictions and for which a right to 'opt out' exists only to the extent that the existing bilateral tax treaties already include a similar minimum standard.
In addition, the MLI includes a number of optional modifications to the existing bilateral tax treaties that will in general only apply if both contracting states to a bilateral tax treaty choose to apply a particular modification. In a case where one of the contracting states has expressed a reservation regarding a provision set out in the MLI, then this provision will not apply with respect to the bilateral tax treaties of that contracting state. It should be noted that the United States is not a party to the MLI.
The MLI provisions and modifications will only become effective with respect to a bilateral tax treaty upon the completion of the ratification procedure of both contracting states. Accordingly, when examining the current version of a bilateral tax treaty in a country that has ratified the MLI, it will be necessary to also check whether treaty provisions have changed as a consequence of the MLI.
Ratification of the MLI by Israel
Israel was one of 68 jurisdictions to sign the MLI during a signing ceremony hosted by the OECD in Paris on 7 June 2017. Other jurisdictions have subsequently signed the MLI.
On 13 September 2018, Israel informed the OECD that it ratified the MLI, making it the 11th country to do so. The MLI came into force with respect to the relevant Israeli tax treaties on 1 January 2019.
As mentioned above, the modifications to the bilateral tax treaties provided for in the MLI, will apply to the Israeli bilateral tax treaties currently in effect, but only regarding:
Israel has chosen to implement the MLI with regard to most of the existing treaties to which it is a party (expect for the treaties with the UK, Germany and Switzerland, with which Israel will sign new bilateral treaties) and has submitted certain reservations to the provisions set out in the MLI.
Main Developments and Changes Following Israel's Ratification of the MLI
Israel has chosen to implement most of the provisions of the MLI as part of its bilateral tax treaties. Some of the modifications will, however, have a significant impact on the provisions of Israeli tax law which apply to international transactions and international structures, involving, directly or indirectly, Israeli residents or Israeli-sourced income. In this regard, non-Israeli residents of a state with which Israel has a tax treaty and who are planning to operate or to invest in Israel, should carefully examine the implications of the MLI on the existing tax treaty between Israel and the relevant state.
Some of the main provisions which Israel has chosen to implement, and their potential implications on taxpayers, are as follows:
Residency of non-individual dual residents (companies, partnerships, trusts etc)
Many of the existing bilateral tax treaties to which Israel is a party, determine the residency for treaty purposes of persons other than individuals (namely, companies, partnerships, trusts and so on) according to the 'place of effective management' tie-breaker test, which is consistent with the provisions of the OECD Model Tax Convention for the determination of residency for treaty purposes of dual-resident entities. An exception in this regard is the tax treaty between Israel and the US, which sets out the Mutual Agreement Procedures as the tie-breaker in order to determine the residency of dual-resident entities.
Article 4 of the MLI changes the 'place of effective management' tie-breaker test and substitutes it with the mutual agreement procedure. Israel has chosen to implement Article 4 of the MLI without reservation and to apply the mutual agreement procedure as the tie-breaker rule for determining the residency of a dual-resident entity, commencing in 2019.
In this regard, the contracting states are not obliged to determine the residency of a dual-resident entity by mutual agreement, but rather, shall 'endeavour to determine' the residency by mutual agreement. This wording is very strict and could lead to double taxation situations where the residency issue is not determined by way of mutual agreement of the contracting states, since in the absence of a mutual agreement, the entity will not be entitled to any relief or exemption from tax under the relevant treaty (unless it was otherwise agreed by, and between, the contracting states).
The change in the tie-breaker rule significantly affects the taxation of certain trusts in Israel. There are many cases in which a trust that is considered a resident of Israel is also considered a resident of another country under the domestic laws of the other country. The new tie-breaker rule creates an absurd situation in which such a trust may be subject to tax in both countries until there is an agreement between the countries on how to tax the trust.
Another example of the potential disputes and problems arising as a result of the implementation of Article 4, is in the case of Israeli incorporated companies which are effectively managed and controlled outside of Israel. Such companies are considered as Israeli-resident companies, since they were incorporated in Israel. On the other hand, the fact that such companies are effectively managed and controlled in another country might cause them to be viewed as a tax resident of this other country. In the absence of a mutual agreement between Israel and the relevant country, such companies will be exposed to double taxation and its consequences.
It should be noted that while Israel has chosen to implement Article 4 of the MLI without reservation, a number of states, such as Germany, Switzerland, Spain, Austria, France and Singapore have chosen not to implement this article. This means, in effect, that with respect to the tax treaties between Israel and states that have not implemented Article 4 of the MLI, the existing 'place of effective management' test will remain as the tie-breaker for the determination of the residency of dual-resident entities.
Permanent establishment status
The concept of a permanent establishment (PE) is one of the most important means for the allocation of taxation rights between states in cross-border transactions. The term PE is defined in most of the bilateral tax treaties to which Israel is a party, and the definition is generally consistent with the definition of this term in the OECD Model Tax Convention. A PE is typically defined as the fixed place of business through which the business of the enterprise is wholly or partially carried on.
In this regard, the Israeli bilateral tax treaties further provide that a PE may be created in a contracting state if the enterprise operates through a dependent agent. Typically, in the existing bilateral tax treaties to which Israel is a party, an agent is considered as a dependent agent if the agent has and habitually exercises, in a contracting state, the authority to conclude contracts in the name of the enterprise, unless the agent is an independent agent (that is, a broker, general commission agent or any other agent of independent status, who is acting in the ordinary course of their business).
Under the existing definitions, generally, a foreign enterprise can carry out business development and marketing activities in Israel, without creating a PE for the foreign enterprise, provided that the agent who operates in Israel has no authority to conclude contracts on behalf of the foreign enterprise.
Article 12 of the MLI extends the definition of a dependent agent to include not only agents with the formal authority to conclude contracts on behalf of the enterprise, but also to agents who habitually play a principal role leading to the conclusion of contracts that are routinely concluded without material modification by the enterprise. Accordingly, although these agents have no formal authority to conclude contracts on behalf of the enterprise, they play a significant role in the conclusion of the contracts, such as participation in the negotiations, all of which might be deemed to create a PE for the foreign enterprise.
Israel has chosen to implement Article 12 of the MLI and to apply the new definition of a dependent agent to its tax treaties with no reservations. Accordingly, certain business development and marketing activities, as well as the pre-sale activity of agents in Israel on behalf of foreign enterprises, which previously were not deemed to create a PE in Israel, might, commencing from 2019, result in a tax liability and reporting obligations in Israel for the foreign enterprise.
Taxation of transparent entities
Generally, transparent entities are entities the income of which is allocated to their shareholder, and the tax on such income is paid by the shareholder as if it was the shareholder's income. In many international structures, double taxation issues or double non-taxation issues may arise where the relevant states classify such entities differently, thereby creating a hybrid mismatch. For example, if the entity's residency state treats the entity as transparent while the shareholder's residency state treats the entity as opaque, it will create a 'hybrid entity.'
Under Israeli tax law, certain entities are treated as transparent for tax purposes, such as family companies, partnerships and specific types of trusts. At the same time, certain types of foreign entities are treated as transparent in the state of their incorporation (for example, United States LLCs, S corporations and Grantor trusts in certain jurisdictions), whereas under Israeli tax law, these are not regarded as transparent entities, resulting in a hybrid mismatch which can lead to situations involving double taxation.
Most of the existing bilateral tax treaties to which Israel is a party, do not include any provisions dealing with the taxation of transparent or hybrid entities. Exceptions in this regard are the new treaties with Canada, Armenia and the treaty with the United Kingdom, which has not yet come into force. These new treaties include a provision regarding transparent entities, similar to Article 3(1) of the MLI, which is explained below.
Article 3 of the MLI sets out rules for determining when income earned through transparent or hybrid entities will be eligible for treaty benefits. According to Article 3(1), income derived by or through a wholly or partially transparent entity under the tax law of either contracting state, shall be considered to be income of a resident of a contracting state but only to the extent that the income is treated, for the purposes of taxation of that state, as the income of a resident of that state. According to this rule, for example, Israeli-sourced dividends that are derived by a partnership which is owned in equal share by a resident of a contracting state (state X) and a resident of a non-contracting state (state Y), will be entitled to a reduced dividend withholding rate in Israel under the treaty with state X, but only on the part of the dividend which is allocated to the resident of state X (while the part of the dividend which is allocated to the resident of state Y will be subject to the full withholding tax rate in Israel).
Article 3(2) of the MLI further provides that treaty benefits might be denied in certain cases of hybrid entities. This might lead to an onerous double taxation situation arising, for example, in the case of an Israeli resident who owns 50% of a foreign partnership in state X (state X treats the partnership as an opaque entity and imposes corporate tax on the income of the partnership), which also derives income sourced in state Y. In such a case, according to Article 3(2) of the MLI, the Israeli resident might not be entitled to a foreign tax credit in Israel on the taxes paid in state X with respect to the partnership's income which was derived in state Y. The result, in such a case, will give rise to unrelieved double taxation.
It should be noted that although Israel has chosen to implement both Article 3(1) and 3(2) of the MLI, without reservation, a number of states, such as the United Kingdom and Luxembourg, have chosen to implement only Article 3(1) of the MLI. It should also be noted that the majority of jurisdictions participating in the MLI have expressed a full or partial reservation to Article 3 in its entirety.