On March 13, 2008 the Israeli Ministry of Finance issued an official press release according to which significant legal amendments and benefits are planned to be introduced in relation to the 60th anniversary of the State of Israel.

The plan includes tax amendments to be enacted as a tax reform aimed, according to the Finance Minister, to encourage former Israeli residents and new immigrants (or “Olim“) to reside in Israel. This planned tax reform is coordinated with the Israeli Ministry of Immigrant Absorption.

Currently, the Israeli Income Tax Ordinance (“ITO“) provides certain tax benefits to New Immigrants as well as to former Israeli residents who returned to Israel (“Returning Residents“). Significant amendments to the current tax benefits include the following:

• Currently under Israeli tax law, a 5-year tax exemption may be provided on passive income (i.e., income from dividends, interest, royalties, rent/lease and annuities) related to assets acquired abroad by New Immigrants and a 10-year exemption on capital gains related to such assets. In addition, a 4-year tax exemption on business income (if sourced from a “business”, which was established during the 5-year period, prior to immigrating to Israel) is provided.
• According to the contemplated reform, the above mentioned tax benefits provided to Olim, will be replaced by a strict 10-year tax exemption with respect to any gains and income. Income and gains for the purposes of the reform are expected to include any class of income/gains from sources outside Israel, including fees/income from personal occupation, and employment income instead of passive income and gains only as currently applies;
• Cancellation of the requirement to report to the Israeli Tax Authorities (“ITA“) with respect to such exempted income or gains;
• According to the Management and Control Principle, a non-Israeli resident company, although established outside Israel, may still be considered as an Israeli tax resident if it is “managed and controlled” from Israel. However, the applicability of this principle is suggested to be annulled with respect to companies that have been managed and controlled from Israel by New Immigrants prior to their immigration to Israel;
• Returning Residents who resided outside Israel for more than 10 years, and return to Israel are expected to be provided with a new “tax status” (“A Returning Resident which is classified as a New Immigrant for Income Tax Purposes“). Returning Residents who will meet the related legal requirements may actually enjoy equal benefits related to their income and gains, as those provided to Olim.  A Transition Provision is suggested for enactment, according to which in 2008 and 2009, Returning Residents will be eligible for the said tax status if they resided abroad for 5 years (instead of 10), provided that they were non-Israeli residents on January 1, 2008 (Currently, Returning Residents enjoy a 5-year exemption on a certain passive income if they were non-residents for only 3 years). As for the 10-year period requirement for these Returning Residents, the following may ensue: If the year of “departure” and the year of “return” are included in this 10-year period, it may be possible that, in some cases, the actual residency outside Israel may effectively be limited to approximately 8-years;
• In addition, a one-year “adaptation period” will be introduced. Accordingly, individuals who immigrate to Israel may retroactively elect, not to be considered as Israeli tax residents during this period, in order to allow them to decide whether they would actually opt to reside in Israel and to be classified as Israeli residents for income tax purposes.

Following this formal announcement, it seems that the scope of current tax benefits would be significantly extended.

However, it should be emphasized that, at this point, the information provided by this press release is very general and lacks legal characteristics. It only gives a general idea with respect to the contemplated tax reform, but it triggers significant questions as for the applicability of such provisions. Therefore, tax practitioners in Israel expect for the actual wording of a draft law to be presented by the Israeli Parliament.

In our view, this contemplated tax reform reflects a new and exceptionally liberal Israeli policy towards Olim and Returning Residents in order to encourage them and to ease their possible transition to Israel. It is, therefore, appropriate that the Israeli Tax Authority follows this direction while implementing the reform in the future while exercising its discretion with respect to specific cases. As a result, it is expected that:

•  The eligibility for the said benefits should be implemented according to tax residency provisions in tax treaties concluded by Israel and not according to Israel’s domestic law;
•  The period of foreign residency for former Israeli residents should start on the day they left Israel permanently (assuming this was their intention) and not one or even two years after they actually left Israel, as it has may some times occur.