Taxation of interest falls into a number of categories, so I shall set out some of the more common examples below.
I shall not be dealing with taxation of interest of private loans (i.e. between two individuals), nor that earned by a shareholder from their company (or vice versa). Similarly, I shall not deal with the question of interest earned as part of a larger business enterprise (e.g. banks).
Interest earned from overseas
For all new or veteran returning residents (from 1st January 2007), interest earned from overseas sources is fully exempt in Israel for 10 years. After that period expires, interest will be subject to tax at the rates discussed below; although interest that has accrued within the 10-year period will be exempt.
For example, a 12-month deposit pays $1,200 interest. The deposit matures exactly 4 months after the 10-year exemption ends. As such, $800 ($1200 X 8/12) will be tax-free, with the balance (i.e. $400) subject to tax.
All other interest income is taxed at the rate of 25% (although interest that accured by 31 December 2011 is taxed at 20%).
Any foreign tax paid on this interest can be offset against the Israeli tax liability.
Israeli-earned income
A פק״מ (Pakam) account is a deposit of non-Israeli currency within an Israeli bank which matures after at least 3 months. Interest earned on these accounts by an Oleh chadash within 20 years of their Aliyah is tax-free. The bank will require a declaration that you are indeed eligible to such a tax-break.
Interest earned on tax and Bituach Leumi overpayments is tax-free.
In certain circumstances, otherwise taxable interest is tax-free during the tax year, up to given limits. The situations are as follows:
(1) A couple (or singleton) whose total joint taxable income (from all sources) for the year is less than NIS 61,560 is entitled to tax-free interest of up to NIS 9,600 per annum. If the joint income exceeds this limit, the tax-free allowance is reduced by a shekel for every shekel that the income is above the limit. E.g. if the joint income is NIS 65,000, the limit is exceeded by NIS 3,440 (65,000 less 61,560) and so the tax-free interest allowed is NIS 6,160 (9,600 less 3,440).
(2) A single person, or one of a couple. who was born in 1947 or earlier and has reached Israeli retirement age, is entitled to tax-free interest of up to NIS 13,200 per annum. There is no income test.
(3) The entitlement in (2) is raised to NIS 16,200 per annum if both spouses meet the age criteria mentioned.
In these cases, the banks are required to deduct tax at source, but the tax authority has a system whereby the tax is refunded directly periodically.
(1) A couple (or singleton) whose total joint taxable income (from all sources) for the year is less than NIS 61,560 is entitled to tax-free interest of up to NIS 9,600 per annum. If the joint income exceeds this limit, the tax-free allowance is reduced by a shekel for every shekel that the income is above the limit. E.g. if the joint income is NIS 65,000, the limit is exceeded by NIS 3,440 (65,000 less 61,560) and so the tax-free interest allowed is NIS 6,160 (9,600 less 3,440).
(2) A single person, or one of a couple. who was born in 1947 or earlier and has reached Israeli retirement age, is entitled to tax-free interest of up to NIS 13,200 per annum. There is no income test.
(3) The entitlement in (2) is raised to NIS 16,200 per annum if both spouses meet the age criteria mentioned.
In these cases, the banks are required to deduct tax at source, but the tax authority has a system whereby the tax is refunded directly periodically.
Interest earned on a shekel account which is unlinked to the prices index is taxed at 15%.
All other interest income is taxed at the rate of 25% (although interest that accured by 31 December 2011 is taxed at 20%).
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