Israel/South Africa Expatriates Face Costly New Tax Rules

In terms of the Right of Aliyah doctrine (the right of every Jew to immigrate to Israel) every Jew going to or intending to go to Israel will be granted an Oleh’s visa. Oleh, for my colleagues not dealing with Israeli law (plural: olim) means a Jew immigrating into Israel. The Oleh Visa is granted by mere expression of the interest to “relocate” to Israel as a qualifying Jew (albeit born outside Israel after 1950).

A person shall not be registered as a Jew by ethnic affiliation or religion and will be denied Oleh Visa, despite being a Jew as defend, inter alia because of political status / activity (i.e. is engaged in an activity directed against the Jewish people or which is likely to endanger public health or the security of the state of Israel) or secondly, where a notification (issued under the Law of Return 5710-1950 as amended by Law of Return (Amendment No. 2) 5730-1970 or a Population Registry Law, 5725-1965 Registry) or any public document, indicated that the applicant or intended Oleh is not a Jew as defined.

For the purposes of Aliyah a “Jew” is defined a person who was born of a Jewish mother or has become converted to Judaism and, of critical importance, who is not a member of another religion and it is presumed a public registry showing baptism in terms of a Christian or other religion may cause some difficulty in applying for an Oleh visa.

During 2013 the Israeli Knesset passed laws that had a severe impact on South African expats intending or in some case have relocated to Israel. At this stage it is important to explain why the Oleh was discussed in detail. The Israeli / South Africa double tax treaty clearly states:

”In the case of a person who is an “Oleh” (as defined in section 35 of the Israeli Income Tax Ordinance), his centre of vital interests shall be deemed to be in Israel”

Effectively, and despite having a permanent home in South Africa (SA) and Israel, the Oleh will be deemed to be tax resident in Israel ONLY, ignoring the fact that the habitual home is in South Africa. In short, none of the other tie breaker rules will favour the South Africa despite being a national of South Africa and not of Israel. The Oleh is elevated, by treaty rules, to be equal to a national of Israel no longer being a SA national.

Non-Jews relocating to Israel will be able to claim SA tax residency based on either their SA nationality or their centre of vital interest being in SA, despite having a habitual home in both countries

The two major tax updates and changes involves one the one hand the favourable fiscal treatment of new immigrants to Israel, or, Olim Chadashim, and secondly the South African Trust income distributions completely ignored by the Israeli tax authorities. All this has now come to an end and Oleh treaty residents deemed tax non-resident in terms of section 1 (of the SA Income Tax Act) will not be liable for additional tax in Israel and as of 2014 may face additional withholding taxes in South Africa.

Olim Chadashim (where Olim is the plural of Oleh) or tax immigrant Jews having entered Israel in terms of the Aliyah doctrine, enjoyed a ten-year tax holiday (calculated from their tax immigration into Israel) exempting the Oleh from Israeli taxes on, or the reporting of, their income earned from a South African source.

For now it seems the tax exemption will stay in place, yet the new reporting requirement, enacted to bring Israel in line with OECD standards) would arguably lead to more revenue as the ten-year grace period is now closely monitored.

The double barrel Oleh approach was to, once a Oleh is tax non-resident in SA and no longer subject to donations tax, donate his remaining SA assets to a South Africa Trust created by someone not tax resident in Israel. More often the assets were sold at arm’s length to the independent trust prior to tax emigration (as emigration would have triggered a deemed market value sale in any event) on loan account. Said loan or balance due to the Oleh, is post tax emigration donated to the trust despite the immediate capital gains consequences for the SA trust or sold for net present value to another resident. Once this trust arrangement was in place, the passive income was tax-free in both SA and Israel. (As of 1 April 2012 the dividends paid to a SA trust or Oleh, were made subject to a 15% DWT or dividend withholding tax effectively allowing the banked dividend cheque to be treated as tax-free income in both SA and Israel).

Despite the 15% DWT in SA, many Olim expats channelled their Israeli-sourced income through a South African company owned by the South African trust, to avoid paying taxes when the corporation’s board of directors declares dividends. (South Africa allows for generous DWT exemptions where there is a corporate group in place. Effectively subsidiaries do not suffer the DWT for as long as they pay the dividend to another SA resident company.)

The hold co dividend (net of 15% DWT) and the tax-free interest (gross) earned by the trust was vested in the deemed tax non-resident and SARS (SA tax authority) could collect no further tax). Being an own funded trust (albeit not self-created trust) the SA Reserve Bank (SARB) allowed the annual vesting of income be remitted from Rand (ZAR) to any foreign currency of choice, as the Oleh’s funding was of greater importance than the trust deed window dressing.

Effectively the use of the SA Trust resulted in an indefinite extension of the 10 year tax exempt window in Israel.

No longer so, the Knesset decided. As of 1 January 2014 a new trust regime was introduced. This article cannot cover all the options yet the reader, often an expat South African Oleh and or the local trustee or tax advisors, need to take note of the changed tax rules.

In the past, trusts settled by either the Olim Chadashim or an unrelated party, generally enjoyed the same tax and reporting exemptions in Israel as the Olim Chadashim themselves yet, the most important part was the tax exemption enjoyed by beneficiaries not entitled to the Olim Chadashim benefit, i.e., non-Olim Chadashim.

Effectively the dividends paid by non-Israeli companies (indirectly from Israeli sources and true SA sources) and interest income sourced in SA and vested in the Oleh, will no longer qualify for tax exemption in Israel. South Africa continues, for now the unilateral tax exemption on interest earned by a non-resident provided there is no SA trade or permanent establishment and the non-resident spends less than 183 days in SA.

Until end 2013, Israel encouraged tax regime said to incentivise Oleh to return yet enjoy tax exemption in respect of both foreign trust income vested and foreign sourced income (i.e. non-Israeli company dividends) as Israel did not tax its residents on any distributions they received from trusts created by foreign person and often Oleh and other beneficiaries were not even required to report such distributions.

It is said the new tax laws effective 1 January 2014, was passed by the Knesset to tax trusts not previously taxed and to move closer to OECD good standing and compliance.

Writer and other learned authors respectfully argue the new Israeli rules dealing with foreign trust income, will severely impact on Oleh and their previously tax free distributions from a South Africa Trust. Where the trust is not a Relative Trust the tax consequences could be dire, as explained below.

Fact is, worst off is the Israeli resident beneficiaries of a trust not defined as “Relative Trust”.

For exchange control reasons (falling outside the scope of this article) many Olim tax immigrants to Israel continue to benefit from tax haven trusts (often trusts outside SA, created in say Channels Islands, now tax “washed” and lily white in terms of our previous Exchange Control and Tax Amnesty Law) that were not dissolved as Israel showed no aggression towards them. Receiving, welcoming and incentivising the Oleh through a 10 year tax holiday were far more important at that stage than now (yet the Google Tax Issues probably changed Israel’s approach and aligned their thinking with that of the OECD).

In short, distributions from truly unrelated trust not qualifying as Relative Trusts, will now be taxed in Israel, no exception as far as writer could determine.

On the other hand, and this is where the South African Trust Administration fraternity need to listen up, trustees of Relatives Trusts must notify the Israeli tax assessor of the existence of such trusts within 60 days of formation or no later than end January 2014.

<strong>Simultaneously, it appears there is a tax rate election to be done before end February 2014.

Option one is the so called Deferred Tax Regime, in terms of which the Israeli tax resident beneficiary (read Oleh expat South Africa) is taxed at 30% on trust distributions when made, albeit that some learned authors refer to received. This is a debate for another time, but in terms of SA law the beneficiary accrues the income on vesting or distribution date. Exchange Control rules may delay receipt to Israel for some time, yet this time delay should be ignored, writer suggests.

Option two is the so called Alternative Regime, in terms of which distributions to beneficiaries are not taxed at 30% as the trust elects to pay tax at 25% per annum. Vested trusts (South African law) may wish to consider this option yet tone has to ensure no non-Israeli beneficiary is caught by the election suggesting that existing vested trusts, to the extent that it may be legally possible, should pour over into an Israeli beneficiary trust and a non-Israeli beneficiary trust.

As the taxation of trust income is at beneficiary level the effective managements rules, allowing SA trustees to escape Israeli tax based on effective management in SA, appears to be irrelevant and of no benefit. Perhaps a blog topic for Israeli based tax advisors?

Electing the 30% default rules, trustees are warned that in terms of Israeli tax authorities there is a presumption that income is distributed before capital. Vesting capital in the Israeli residents may thus not be the tax escape of the past.

We return ti the treaty benefit where effective management of the trust is outside Israel. In the past the District Court of Tel Aviv determined that the relevant tax treaty provisions should be read in light of the local anti-avoidance rules, giving preference to the Israeli anti-avoidance rules. This interpretation could be problematic and SA Trustees should approach SARS (as competent authority) to insist Israel, in accordance with Articles 26 & 31 of the Vienna Convention on Double Tax Treaty implementation, should implemented the new regime in good faith. The Vienna Convention in article 27 provides, that signatory (Israel) may not favour its internal law as where treaty rule fails their tax avoidance intention. It is however their stated policy that:

Once a treaty is made part of Israeli law, its provisions take precedence over domestic law.

What then is the relevance for South Africans trustees (and perhaps trustees in other jurisdictions) advising Oleh clients? In South Africa we have the added issue of formal emigration in terms of our Exchange Control rules.

Writer now pose the following questions:

1. What is the continued benefit of the SA trust? To date very few Oleh client’s formally emigrated as they preferred to keep the SA trust in place, for tax reasons mentioned above. Often local inheritances were added to the local trust and the accepted and thus legal non-disclosure saved millions in taxes.

2. Carefully consider the soon to be implemented interest withholding tax in SA. The expected withholding tax rate is 15%, well below the 25% allowed in terms of the treaty. As the treaty is not currently listed as under negotiations, the SA trust must in future be denied a tax deduction in respect of interest paid or vested to Israel. Using family money to fund highly geared SA businesses not paying any local nor may Israeli tax (due to the interest deduction not being taxed by Israel prior to January 2014) soon fall foul of SARS anti-avoidance rules and transfer pricing rules. It is time to re-consider the Oleh Trust structure, not only because of the SA tax changes but more importantly because your Olim Chadashim 10 year tax holiday may be running out and “innocent” but new reporting obligation is feeding Big Brother with tax sensitive data. Who knows that the data may lead to, a reduction of the 10 year holiday for your children not yet indicating their wish to avail to their Oleh Visa?

3. How up to date is your SA trustees on Israeli law? Previously I was often told pre-emigration planning involved placing your SA Trust with a big English Speaking Trust Company and appointing your Afrikaans lawyer as the independent trustee. They were not at risk as there was no Israeli reporting obligation, the trust ensured generation skipping for estate duty purposes and if the children in SA did marry a Jew, the family money was “kosher”. It is no longer so simple, the “kosher fund” in SA will no longer escape the attention of the Israeli authority.

In closing, writer used the various terms with the greatest of respect to his Israeli and Jewish client base, which consists or both emigrants and fellow Chartered Accountants.

In accordance with Circular 230 Disclosure

Hugo is a Chartered Accountant (South Africa) registered with The SA Institute of Tax Practitioners and SARS as a Master Tax Practitioner. He is in daily contact with expat South Africans (aka SAFFAS or Wegkaners) where ever they live and has lectured from LA to London and although many clients now reside in Australasia, Hugo has never visited either Australia nor NZ. Bucket List I hear you say. Hugo is also a Trust and Estate Practitioner (STEP). Cross border taxation and Exchange Control are both high on his priority, be it for emigrants, immigrants or multi-nationals.

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2 comments on “Israel/South Africa Expatriates Face Costly New Tax Rules

  • Hi Hugo,

    Thanks for this important post; the issue of Israeli residency is indeed complex. As you rightly indicated, making Aliya will be a significant factor in recognising an individual as an Israeli tax resident. However, in practice there are cases where individuals made Aliya for various reasons and are not considered Israeli tax residents. The ITA looks at the big picture: location of family, place of work, days spent overseas etc. These details and others become very important when examining residency especially when it’s part of the family tax planning.

  • Gidon, thank you. Indeed you are so correct and we have seen cases where in terms of the tax treaty, our SARS refused to allow a tax exit from South Africa despite the following words in the treaty: “In the case of a person who is an “Oleh” (as defined in section 35 of the Israeli Income Tax Ordinance), his centre of vital interests [ refer your reference to the big picture] shall be deemed to be in Israel”. Twice we won the case because of the habitual home rule found in the treaty. Interesting to note habitual home is absent in the more modern treaties SA signed since the new regime took over in 1994. The Israel / SA treaty was signed by Owen Horwood in 1979/1980 nearly 35 years ago. Once again thank you for alerting us to the complexities in determining tax residency status.

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