Alon Kaplan and Shai Dover
Israel is a small country, about the size of Belgium or New Jersey. Located on the eastern shore of the Mediterranean Sea, Israel is at the crossroads of Europe, Asia and Africa, and maintains important political and economic ties with North America. Although located in the Middle East, Israel is culturally a European country with a democratically elected government and a legal system based on Anglo-American traditions.
According to Israel’s Central Bureau of Statistics, the country’s population stood at 7.1 million at the end of 2006, eight and a half times larger than on the eve of the Independence in 1948, when the population was just over 800,000. Over those 60 years, 4.6 million births were recorded, and “Sabras,” native-born Israelis, now constitute 66% of the Jewish population compared with 35% when the country was established.
The Israeli economy is based heavily on foreign trade, especially in such high added-value areas as information technology, biotechnology and aviation. Total industrial exports, exclusive of diamonds and defense products, exceeded $35 billion in 2006, more than $5,000 per capita. Exports of services brings the total to more than $55 billion Much of this export success is due to a national commitment to research and development: Israel spends about $1,000 per capita annually on civilian R&D, 25 percent more than the United States and 50 percent more than OECD countries. GDP per capita was $19,800 in 2006, five percent higher than 2005. Unemployment stood at 8.1 percent in 2006, down 20 percent over 2004, while inflation, once a major issue, is now nonexistent. Israel’s economy is larger than those of all its immediate neighbors combined and the number of its companies traded on Nasdaq ranks behind only the United States and Canada.
The health of the Israeli economy is reflected in its ability to draw foreign investment: Inward direct investment reached $14.2 billion in 2006. Foreign investors are encouraged by reports such as the World Economic Forum’s Global Competitiveness Index. For 2006-2007, the GCI ranked Israel in 15th place overall worldwide, in first place by availability of scientists and engineers and in second place for venture capital availability. The index also ranked Israel in third place for judicial independence, and in fourth place by quality of scientific research institutions and by technological readiness.
Many Israeli companies have become world leaders in their fields, including Check Point Software, Comverse Technology, Elbit Systems and Teva Pharmaceuticals. Technologies such as voice-over-internet-protocol and instant messaging were developed in Israel.
A host of multinational technology firms have established R&D centers or manufacturing facilities in Israel. These include Intel, Google, Microsoft, Motorola, Toshiba, Sun Microsystems. Lucent, Nortel, Cisco, Ericsson, Siemens, Hewlett-Packard and 3-Com also maintain a local presence via equity investments in Israeli companies.
Banking
Israel maintains a modern computerized banking system. Most banks provide private banking services and maintain special centers for tourists and foreign investors. The five large Israeli banks have branches in Europe and the United States and representative offices in other countries.
Law of Inheritance
Israeli inheritance matters are governed by the Succession Law, 1965. The law does not mandate a specific portion to family members. It does, however, protect the surviving spouse, children and dependent parents by providing for maintenance payments from the estate. Israeli courts have jurisdiction over individuals who, at the time of death, were domiciled or owned assets in Israel. A person can inherit either under a will or by law.
Where no will exists, the law provides for the property to be divided among the surviving relatives. A common law spouse, who was living with the deceased as husband or wife, is considered “married” under this law.
Trust Law
The trust institution has been recognized under the Israeli legal system since the 1920s. The enactment in 1923 of the Charitable Trusts Ordinance set the rules for a public trust. The private trust was not regulated by statute until 1979, when the Trust Law was enacted.
One peculiar feature of the Trust law is its failure to permit generation skipping, i.e., one cannot create a trust to survive the life beneficiary for the benefit of his successor. A valid will and probate procedure is required.
Taxation
The Israeli tax system is based on global taxation, which determines tax liability for an Israeli resident, whether the income is accrued or received in Israel or abroad. A “mini-reform” effective as of January 2006, deals with taxation of trusts, underlying companies, pre-rulings, participation exemptions, exemption for foreign residents from tax on capital gains from the sale of shares, establishment of real estate investment trusts in Israel, and more. The mini-reform also decreased the tax rates on individuals and companies on certain types of income.
Companies in Israel are generally subject to company tax on their profits, at the rate of 29% on taxable income (to be reduced to 27% in 2008, 26% in 2009 and, finally, 25% in 2010). Distributed profits after company tax are subject to dividend withholding tax at rates of 20% or 25% (starting January 1, 2006 the rate is 20% for a shareholder who is not considered a “substantial shares holder”). These rates apply both to foreign individuals and foreign companies. In the case of a non-resident individual, interest income is generally liable to withholding tax of 15% (if it is not or only partially linked to the consumer price index) or 20% unless reduced by a tax treaty. Lower tax rates and other benefits are applicable under Israel’s investment incentive legislation.
Regarding personal taxation, Israel imposes progressive tax at rates of up to 48% (to be reduced to 48% in 2008, 46% in 2009 and, finally, 44% in 2010). Credits, deductions and exemptions are given based on residency, sex, number of children, disabilities and more.
Foreign Residents
Foreign residents enjoy a range of tax benefits such as the law for encouragement of capital investment, exemptions for trusts, participation exemption and more, all aimed to attract foreign investors. Foreign residents, will, in principle, continue to enjoy a range of exemptions that cover income from passive investments in Israeli banks. However, foreign residents will be subject (as they are in most western countries) to tax on capital gains derived from Israeli assets, except for gains from the sale of publicly traded equities and the sale of securities of a public or private Israeli company bought between July 1, 2005 and December 31, 2008, provided certain conditions apply.
Other taxes
Value added tax (VAT) is generally imposed on transactions conducted in Israel, as well as on transactions relating to assets or activities in Israel and imports. The standard rate of VAT in Israel is currently 15.5%, but exports are generally zero-rated. Special provisions apply to financial institutions and non-profit bodies.
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Israel has no inheritance or gift tax. However, on the subsequent sale by the recipient of an asset which is assessable for capital gains tax, the asset cost (net of depreciation where applicable) and acquisition date of the testator or donor are taken into account in the computation of tax due.
Double taxation relief
Israel is a party to more than 40 double taxation treaties. The foreign investor who takes advantage of double taxation treaties can often withdraw profits earned in Israel under favorable tax treatment.
Taxation of Trusts
On January 1, 2006, the Taxation of Trusts Law came into effect in Israel. This law defines four types of trusts.
A. A trust of Israeli residents. This trust is taxable on its world wide income according to Israeli law and according to the tax rates applicable to individuals.
B. A foreign settlor trust. This type of trust makes Israel attractive to foreign residents. Whether or not the trust is irrevocable, a foreign settlor trust is considered a foreign resident. The assets held by the trustee are viewed as assets held by an individual foreign resident and the trust’s income is viewed as the income of an individual foreign resident. If the trust profits are not derived from sources in Israel, they are not taxable in Israel and there are no reporting obligations in Israel.
C. A foreign resident beneficiary trust. Such a trust may be established by an Israeli resident for a foreign resident beneficiary. In such a trust, assets and the income derived therefrom are taken out of the Israeli tax network.
D. A will trust. This type of trust must is established by a will and the testator must be an Israeli resident at the time of his death. It will generally be taxed as a trust of Israeli residents or as a foreign resident beneficiary trust, depending on the beneficiaries’ residency.
Underlying company
One of the major changes of the Taxation of Trusts Law is the underlying company within Israel or abroad. An “underlying company” may be a company, foundation, partnership, etc. The company is regarded as a “flow through entity” and the “management and control” test is no longer relevant.
Conclusion
Israel is a small country with a strong economy, a modern banking system, an educated population and laws aimed at attracting foreign investors. The Israeli tax system has undergone a substantial overhaul in the past few years, including, most recently, the taxation of trusts. The Taxation of Trusts Law is intended to close certain lacunae with respect to Israeli residents while maintaining Israel’s policy of providing certain benefits to foreign residents. Further, the underlying company may be advantageous to certain foreign residents as an investment vehicle for income derived from sources outside Israel. Israel may be the right venue for certain foreign residents to form their financial planning center.
This article provides a general overview only, is not intended to provide legal advice to any party and therefore should not be relied upon without independent professional advice.
Alon Kaplan, LL.M., TEP, is the Chairman of STEP Israel.
Shai Dover, C.P.A. (Israel), TEP, is Editor of the STEP Israel Yearbook.
All data in this article are from the Central Bureau of Statistics, the Israel Export and International Cooperation Institute or the CIA World Factbook.
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