Further to our circular dated 28th of April, 2013 regarding proposed amendments to the taxation of trusts in Israel, we wish to further update you that on June 11, 2013 the government submitted to the Knesset (i.e., the Israeli Parliament) the blueprint of a new bill which is referred to as the Bill for the Change of National Priorities (Legislation Amendments for the Purpose of Achieving the Budget Purposes for the years 2013 and 2014) (the "Bill"). The Bill includes, inter alia, the suggested changes to the taxation of new immigrants in Israel.

The procedure for adopting a new law in Israel, following the publication of a government proposed bill, is as follows. The bill first needs to pass a "first reading" in Knesset; it is then submitted to the Finance Committee for further review and edits. After it is approved by the Finance Committee it is returned to the Knesset for a "second reading" and then a "third reading". Once the bill passes a "third reading", it is published as an official law. The Bill is part of the government's budget for 2013-2014 and is expected to pass into law by July 31, 2103. As a government proposal, it is highly unlikely that the Bill will not pass a majority vote in the Knesset, however certain adjustments may still be made. We will keep you informed of any changes or developments that arise.

We have described below the main changes that are included in the Bill with respect to the taxation new immigrants:

  1. Cancelation of the exemption from reporting obligations.

Under the current legislation, New Immigrants are not subject to Israeli reporting obligations with respect to their foreign source income and assets for a period of ten years. The Bill abolishes this relief and requires New Immigrants to report their foreign source income or assets regardless of any tax exemption to which they are entitled. This change will only apply with respect to new immigrants who arrived in Israel after the new legislation becomes effective.

  1. Taxation of Dividends received by new immigrants.

According to the Bill, if a dividend has been distributed by a foreign company, but was distributed from income which was derived in Israel, then such a dividend will not be classified as foreign sourced income, and accordingly, will be subject to tax in Israel.

  1. Exemptions Provided to Companies Held by New Immigrants.

The Israeli tax laws include two main anti-deferral regimes –

  1. Controlled Foreign Companies Regime (CFC). As a general rule, according to the Israeli CFC legislation, the passive income of a foreign company should be allocated, under certain circumstances, to its Israeli shareholders as if this passive income was distributed as a dividend to them.
  2. Foreign Occupation Companies (FOC). As a general rule, a foreign company that is used by Israeli residents in order to provide services outside of Israel, is considered, under certain circumstances, to be an FOC. Part of the income of an FOC, which is derived from such services that are provided by Israeli residents, is subject to tax in Israel.

New Immigrants are not subject to the CFC and FOC regimes and the Bill does not propose to change this. However, the Bill makes a significant change regarding the way in which the New Immigrant affects his Israeli partners in the CFC and the FOC.

As a general rule, one condition that must be satisfied for a foreign company to be a CFC or FOC is that more than 50% or 75% (respectively) of its means of control1 are held by Israeli residents.

According to current legislation, New Immigrants are considered as foreign residents and therefore their immigration to Israel does not affect the taxation of their Israeli partners in the foreign company. The Bill proposes to treat New Immigrants as Israeli residents when calculating the percentage of Israeli means of control and not to treat them as foreign residents.

The effect of the Bill's proposal can be illustrated in the following example. Suppose that the New Immigrant holds 65% of a foreign company and an Israeli resident holds 35%. According to current legislation, the interests of the New Immigrant are taken into account and regarded as those of a foreign resident. The foreign company is therefore not considered as a CFC, since Israeli residents hold less than 50% of the means of control and both the Israeli resident and the New Immigrant are not subject to tax on deemed dividends from the foreign company's income. According to the proposal in the Bill, the New Immigrant will be considered as an Israeli resident and therefore Israeli residents will hold 100% of the means of control. Such a company will become a CFC upon the immigration of the New Immigrant to Israel and the Israeli resident will be regarded as having received its share of the foreign company's income as a deemed dividend (the New Immigrant will remain tax exempt).

  1. Cancelation of the exemption provided to certain new immigrants trusts

Under current legislation, a trust which was settled by a new immigrant is entitled to the same tax benefit to which the New Immigrant is entitled (i.e., 10 year exemption on its foreign sourced income). These benefits are currently provided even if the beneficiaries are Israeli residents that are not entitled to these benefits. The Bill suggests to significantly narrow this provision and to determine that a trust which was settled by a new immigrant will be entitled to the 10 year exemption only to the extent that its beneficiaries are also entitled to this exemption