Calculation of tax

One of the more common questions that an accountant is asked is "how much can I earn without paying tax?"

Whilst the question is relatively straightforward, the answer is essentially "it depends."

This aim of this post is to give a very basic overview of how your tax bill is calculated, with details to come in later postings.

1. Work out your taxable income according to type of income e.g. Self-employment, salary, interest, dividends etc. Don't forget to deduct legitimate expenses first.

2. Certain non-business expenses are allowed, at least in part, by the tax authorities. E.g. Disability insurance, payments to Bituach Leumi (certain circumstances only) and some pension contributions. These deductions also need to be attributed against the types of income.

3. Once you have the final taxable income, you can calculate the gross tax payable.

Earned income (e.g. salary) is taxed at rates starting at 10% and going through 14%, 21%, 31%, 34% and up to 48% for (total) incomes over NIS 501,960 per annum.

Unearned income (e.g. rent, interest) is taxed similarly, but the first three bands are not given, i.e. the rates start at 31%. The unearned income is taxed after the earned income, so if you reach the 34% bracket with your salary, your unearned income will continue from there, and not go back to the start of the 31% bracket.

However, the law limits the tax rate to certain percentages in certain situations. The most common of these are interest (25%), dividends (25% or 30%) and capital gains (25% or 30%).

Additionally, anyone earning in excess of NIS 811,560 in 2013 (cumulative for all sources of income) is subjected to a 2% surtax on the excess.

4. Against the gross tax payable, you can offset credits. These reduce your tax bill, but will not result in a refund if your credits exceed your gross tax liability.

Credits fall into two broad categories - those based on personal circumstances (dealt with via the "points" system) and those based on certain payments made during the tax year. A fuller treatment of credits will come later (בלי נדר).

5. If you paid foreign tax on any of your Israeli-taxable income, you need to calculate how much foreign tax credit you can claim against the Israeli income. Again, a fuller treatment will be forthcoming in a later blog.

6. Finally, there are certain types of income for which no other credits are given. So your final tax bill will always include the tax on these sources regardless of your credits. We will cover these in their appropriate places.

So there you have it. A very basic outline of how your Israeli income is calculated, and how much you can earn before paying tax depends on (at least), what type(s) of income you have, where it is earned, and how many credits you are eligible for.

 

None of the above takes into account liabilities for Bituach Leumi - but that's a different story altogether.

Are you required to file a 2012 Tax Return?

The Tax Law states that every Israeli resident is required to file a tax return every year, and doing so late results in hefty penalties (in excess of NIS 1,000 for each month between the official deadline and the actual filing).

That being said, a supplementary ruling to the law grants exemptions from filing if you (and your spouse - assume this the whole way through this post) meet certain criteria.

The exemptions are in place in order to relieve the burden on the already-overstrechted tax authorities having to process tax returns for people who won't have any supplementary tax to pay anyway.

There are though certain people whose circumstances dictate that they must file, regardless of their earnings. If you fall into at least one of the following categories, you must file a return:

(1) You are a controlling shareholder (10%+ ownership including holdings of close family) of a company or similar corporation. This applies to all Israeli corporations, and many overseas corporations.
(2) Income of husband and wife is assessed together, rather than seperate calculations.
(3) You received severance pay that was spread over a number of years - one of those years being 2012 (known as פריסת פיצויים).
(4) You were required to file a tax return for 2011, but not for one of these reasons.
(5) You own shares in a non-publically traded non-Israeli corporation.
(6) The value of your overseas assets at any point in 2012 exceeded NIS 1,839,000. This requirement is not relevant for those who fall into the "10-year exemption" for new olim.

So, assuming you do not meet any of the criteria above, you are exempt from filing a 2012 tax return if your income in 2012 was exclusively from the following list. If you had income from any other source, you are required to file:

(1) Salary (including pension and פיצויים) - if the gross amounts received were less than NIS 638,000 (per spouse) and tax was deducted at source.
(2) Rental income (above the exemption limit), provided that (a) the total gross rents were less than NIS 331,000 and (b) the 10% tax was paid by 30 January 2013.
(3) Foreign interest, dividends, capital gains etc, provided that (a) the total gross income was less than NIS 331,000 and (b) the tax (the rates depend on the exact nature of the income) was paid using the "short form" at the post office or online by 30 April 2013.
(4) Foreign pension, provided that (a) the total gross income was less than NIS 331,000 and (b) no tax is due in Israel under the provisions of section 9c of the tax law (beyond the scope of this post - perhaps I'll address it some other time).
(5) Israeli-sourced interest and/or linkage income, provided that either (a) it is exempt from Israeli tax or (b) tax was deduced at source and the gross income was less than NIS 632,000.
(6) Capital gains made on the sale of publically listed shares provided that either (a) it is exempt from Israeli tax or (b) tax was deduced at source and the gross sales were less than NIS 1,823,000.
(7) Other types of income which are subject to tax and tax has been deducted at the maximum rate.
(8) Other income exempt from Israeli taxes.

If the total gross income of (7) and (8) combined is at least NIS 331,000, no exemption is granted.

Whilst this looks a little daunting, in many situations the requirement or exemption from filing is reasonably clear - but if in doubt, take professional advice.

Some basics of Income Tax

מס הכנסה (Income Tax) is the primary tax authority in Israel, equivalent to HMRC in the UK and the IRS in the USA.

Before going into depth on any one subject, it is worthwhile to look at some of the basic concepts within the Income Tax Law.

• Israeli residents are subjected to Israeli taxation on their worldwide income. A credit is given for foreign tax paid.
• Non-Israeli residents are subject to Israeli taxation only on their Israeli-earned income.
• The tax year runs from 1st January through to 31st December.
• Tax files are joint between husband and wife. Whilst the tax calculations are generally seperate, both husband & wife are responsible for payment of the tax owed by the other.
• Income is classified as either earned (e.g. salary, self-employment) or passive - with differing tax rates applying. There is also a difference to the calculation of ביטוח לאומי depending on the defintion.
• Income considered joint (most types of passive income) is taxed as being earned by the higher earner of the couple.
• Tax is to be deducted at source by employers on salary income, and by banks on interest, dividends and capital gains earned through the bank.
• There is also a system in place for self-employed contractors and corporations to pay tax during the year, by a mixture of tax at source and payments on account.
• Tax owed should be paid by the end of the tax year, i.e. 31 December. Any tax owed but not paid by that date is subject to interest (4% per annum) and הצמדה (linkage to the retail price index).

All of the above is of course subject to the various exemptions and concessions granted in the law and Double Tax Treaties, and also the interplay with other taxes (e.g. מע"מ, מס שבח, ביטוח לאומי).