Your Taxes: Look before you leap out of Israeli fiscal residency

Israeli residents relocate abroad for a variety of reasons, sometimes business and sometimes personal, such as being fed up with the war.

If the relocation is for a short period, individuals remain Israeli residents. If they work abroad, they may claim various expense deductions for Israeli tax purposes and claim a foreign tax credit if they are taxed both in Israel and abroad.

A clean break is necessary according to Israeli court cases (e.g., the Zach Case).

An individual who intends to stop being an Israeli resident must satisfy a four-year test to be deemed a foreign resident from the outset.

The test is satisfied if: (1) the individual has been outside of Israel for at least 183 days for two tax years (ending December 31); and (2) the individual’s center of living is abroad in years three and four. Residency should be in another country, not nowhere (the Rafaeli case).

Becoming a non-Israeli resident does not mean paying no more tax.

First, there may well be taxes and social security to pay abroad.

Second, Israel has an exit tax. Individuals who become nonresidents are generally liable to Israeli capital-gains tax at rates of 25% to 50% as if they sold their worldwide assets at market value one day before they ceased to be residents.

This “exit tax” also applies to, inter alia, employee share option plans (ESOPs) and restricted stock unit (RSU) arrangements, which can trigger double taxation if exercised and/or sold once abroad.

The exit tax is payable upon departure or upon the sale of the relevant assets, at the taxpayer’s choice. An exemption applies if the tax will be due later in Israel upon disposal; for example, regarding Israeli real estate.

Proposals exist to tighten these rules. The 10-year clock for national tax breaks for new or senior returning residents doesn’t stop if they leave Israel. Third, for Israeli national insurance purposes, it generally takes five years to lose Israeli residency.

This should give medical cover on any trips back to Israel. Individuals employed by a foreign employer should pay up to 12.17% Israeli national insurance (the rate for passive investment income).

If they work in a country with a social security agreement with Israel, that may decrease to 5.17% (the rate of “health tax”). Israel has social security treaties with around 20 countries, including the UK and Canada, but not with the USA or Quebec in Canada.

Israel has tax treaties with around 60 countries.

Each treaty contains a “tiebreaker” rule for resolving cases of dual residency, i.e., when two countries regard you as a resident under their domestic legislation.

This is quite possible if Israel applies its four-year test and another country has no such test. The tiebreaker clauses typically look at: (1) permanent home; (2) center of vital interests; (3) habitual abode; (4) citizenship.

The individual worked there for a subsidiary company of an Israeli group. The individual also returned to Israel to serve the country for less than 90 days per year (23 days in 2011 and 55 days in 2012).

The ITA ruled that for tax-treaty purposes, the individual stopped being an Israeli resident so long as the individual spent no more than 90 days in Israel, and the spouse no more than 75 days.

For domestic Israeli purposes, according to the ruling, Israeli law continues to apply, such as the four-year test and the exit tax.

Look before you leap out of an Israeli residence.

In our experience, the biggest problem concerns ESOP plans. The most bewildering issue is the four-year limbo period waiting to see if you meet the four-year non-residency test. If you don’t, back taxes, interest, and fines may await you.

Israel now has tax rates below the OECD average and no estate or inheritance tax, but many countries do. And the human factor matters: uprooting family members and leaving others behind isn’t always easy.

As always, consult experienced professional advisors in each country concerned at an early stage in specific cases.