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.
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.