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27 February 2014

Taxation of foreign income and the 10-year rule

Since 2003, Israel has joined the rest of the Western world in taxing its residents on their worldwide income.

Israel has also signed a number of Double Taxation Treaties with other countries which set out various rules for which country can tax certain incomes and in what scenarios. The Double Tax Treaties override the local tax law, so you get the best of both worlds.

This post will assume that a Double Tax Treaty is not in force, or that the income is taxable in Israel anyway. Of course, advice should be taken on taxation of the income in the country of origin. Furthermore, this post relates to Income Tax only, and does not consider the Bituach Leumi aspects of earned income, or the equivalent abroad.

Tax on foreign income

In general, income from overseas is treated and taxed in the same way as Israeli income, and the same rules and rates apply. Israeli tax law though allows you to reduce the Israeli taxes due on that income by taking a credit for any foreign taxes paid. (See here for the classic exemption of property income.) Of course, the credit is limited to the lower of foreign taxes actually paid and the Israeli taxes due on that income. Or in simple terms, you'll end up paying the highest rate between the two countries, but never more.

To make things somewhat complicated, the law allows you to claim foreign taxes paid in one country against taxes due on income earned from another country - but only within the same "income basket". For example you can claim UK taxes paid on UK interest against interest earned from all corners of the Earth, but not against foreign dividend or self-employment income.

Another complication is the calculation of the Israeli tax considered due on foreign income. For fixed-rate incomes (e.g. interest, dividends etc.), the fixed rate is applied to the foreign income. That's fairly easy. But for incomes where the tax rates are based on the bands, the calculation gets very complicated, and it's fair to say that someone with both Israeli and foreign types of this income ends up paying significantly more Israeli taxes than had they not had the foreign income at all - even if the foreign income is well in excess of what the Israeli taxes would be. If that sounds complicated and unfair, that's because it is - and there's no remedy under the current legislation.

Exchange rates

Of course, Israeli taxes are based on the shekel values of incomes and overseas taxes paid. The tax law states that each transaction is to be translated at the official Bank of Israel exchange rate.

That's not always practical, and in that situation I would use the average exchange rate, either for the month or the whole year.

The 10-year rule

Anyone who became a new resident of Israel (Oleh Chadash), or is considered a veteran returning resident (lived out of Israel for at least 10 years) from 1st January 2007, is entitled to a 10-year exemption from paying Israeli taxes on non-Israeli income. The 10-year starts on the day that their residency is considered to have changed to Israel, and ends on the 10th anniversary.

The definition of non-Israeli income is crucial here. The tax law defines where different types of income are considered to have been earned. The most important element for this post is that self-employment income is considered earned in the country in which the work is actually done. What that means in practical terms is that anyone working from Israel for a non-Israeli organisation is considered to be earning Israeli income, which is subject to Israeli taxes, even within the ten years.

16 February 2014

Mikdamot (tax payments on account) and the אישור ניכוי מס במקור

Anyone receiving income from a salary knows that their employer will deduct tax at source, in accordance with the tax and Bituach Leumi laws (see also here). As such, the government gets regular tax revenues from employees; how often depends on the size of the employer.

In a similar fashion, the government asks that advances be made towards your tax liability from your self-employment (or otherwise untaxed) income. These advances are known as mikdamot מקדמות. It is important to note that the mikdamot do not reflect the final taxes due; these will be finalised when you file your annual tax return.

For anyone with a self-employment business, the advances are calculated as a percentage of your monthly or bi-monthly business turnover (i.e. income [excluding VAT] before expenses). This percentage is set based on your previously filed tax returns (i.e. mikdamot for 2014 are currently based on 2012 taxes, but may be adjusted [usually only upwards] once the 2013 return is filed). For a new business, the percentage will be based on statistical tables - using your declared type of business and expected turnover (which you provided when you opened the file).

If both husband and wife have self-employment businesses, the reported income is the joint income for both on a monthly or bi-monthly basis.

If mikdamot are required in a given tax year, you will receive a booklet in order to report the income and pay the tax. This needs to be filed and paid (at the post office) by the 15th of the month following the reporting period. Alternatively, it is possible to report and pay online (here); and doing so will give you a filing extension until 6:30pm on the 19th.

That being said, the tax office has another way in which to collect taxes on an ongoing basis. Under certain conditions, your customer will be required to withhold tax at source on any payments being made to you - even though you are not being paid as an employee. For regular "contractor" income, the rate of tax to be withheld at source is 30%. Of course, this is tax paid, and can - and should - be reclaimed on your tax return.

However, the tax office is empowered to reduce, or even cancel, the requirement to withhold tax from payments to a self-employed person. In order to do this, a request must be sent to the tax office - this on done on this form, or via your accountant.

If a reduction or exemption has been granted, a certificate confirming this should be given to the customer. These can be accessed here. You can then have the certificates email to you. This certificate is known as an אישור ניכוי מס במקור (certificate of deduction of tax at source).

For new businesses, the tax office will typically approve a reduced rate (maybe 3% or 5%), and will be valid for 6 months; after which you will need to renew the certification. For older businesses with a track record of reporting and paying taxes on time, a full exemption should be granted. These are normally extended automatically on 1st January, and are usually valid for 15 months.

If you are required to pay mikdamot, and have had tax deducted from your income in the reporting period, you can offset the tax deducted against your mikdamot due. Furthermore, don't forget to ask the payer to issue you with form 857 at the end of the year, which will summarise the gross payments made and taxes deducted from you during the tax year. You will need this form in order to claim the tax withheld in your tax return.

6 February 2014

Bookkeeping as a freelancer

As a freelancer, you are required to keep a set of records to keep track of your income and expenses. There are a number of professions that need to keep extra documents and records, and you should take advice from a professional to see if any of these apply to you.

This post will set out the major requirements for most businesses. Larger businesses (based on both turnover and number of employees) have more stringent requirements. Again, specific advice should be taken in these situations.

Income documents

Any time you receive income, you are required to issue a receipt - קבלה. This will state the amount received, and the method of receipt (cash, check, credit card, bank transfer etc.)

For any osek morshe (see here for definition), you also need to produce tax invoices - חשבוניות מס. The tax here refers to the VAT charged on the transaction. For any service provided, the invoice is produced when monies are received. As such, it is possible to combine the invoice and receipt - חשבונית מס/קבלה.

However, if you are selling goods, the invoice must be produced when the goods are transferred to the customer. As such, the invoice and receipt dates may well be different (and could cause cash-flow issues).

The invoice sets out what is being charged for, the amounts due before addition of VAT, the VAT due and the gross total.

Receipts and invoices both need to be bespoke for the business, produced in duplicate (at least - one copy for the customer, and one for you) and sequentially numbered. Please note that generic receipts and invoices (available in stationery stores) do not meet the requirements of the tax authorities.

Recording income and expenses

The income and expenses need to be recorded in a "receipts and expenses book" - ספר תקבולים ותשלומים. Here you record the income- which you split between pre-VAT and VAT, as applicable.

Expenses are recorded in a similar fashion, separating out the VAT that you are claiming on the expense, if relevant. The rest of the expense is then categorised, so that your profit and loss account (which will be attached to your tax return) can split out expenses per category.

Once all records are recorded, you will be able to produce your VAT and mikdamot (tax in advance) reports. Feel free to email me for a pamphlet discussing on further details how to do this.

It is also very important to keep all of your original documents (both income and expenses) in a file. Ideally these should be cross-referenced to your receipts and expenses book for easy finding.

It is possible to produce all of the above using software approved by the tax authorities. There are also a number of online programs available. Again, please feel free to email me and I will send you a list of those that I (via clients) have found.

One final point. The official languages of Israel are Hebrew and Arabic. As such, all documentation and recording must be done in at least one of these languages. English can of course be used, provided that one of the aforementioned languages is used as well.