In the face of revenue shortfalls, the Israeli tax authority has recently focused its efforts to crack down on tax evasion by going after Israelis who have left the country without properly breaking tax residency. Although these rules and collection efforts are not new, this new compliance initiative highlights the critical importance for Israeli residents and their employers to understand the tax implications of relocating outside of Israel. Through education and proactive tax planning, unexpected scrutiny and surprise tax bills can be avoided.
The current crackdown by the Israeli tax authorities focuses on Israelis who have relocated to the Republic of Cyprus (Cyprus). This location is the focus of the Israeli Tax Authority’s (ITA) compliance initiative because Cyprus is considered a tax haven and has attracted many Israelis to move there, purchase real estate, and form companies. In addition, the ITA has limited data because the two countries have not concluded an income tax treaty.
At the heart of the issue is the definition of tax residency for Israeli tax purposes, regardless of whether the taxpayer is relocating to Cyprus or elsewhere. Here, the ITA determines tax residency primarily based on the concept of one’s Center of Life (CoL). In Israel, individuals are subject to taxation based on their residency status rather than their citizenship. And, if your CoL is in Israel, you are considered a resident for tax purposes and taxed on your worldwide income, even if you are living outside of Israel.
The good news is that it is possible to relocate your CoL outside of Israel to potentially achieve non-resident status and reduce your tax obligations. Unfortunately, many departing Israeli’s fail to take the steps necessary to “disconnect” their CoL, which may lead to audits and unexpected financial and legal considerations. For this reason, it is critical for departing Israelis to understand the rules for tax residency.
The determination of CoL for Israeli tax purposes considers various factors, including the location of family ties, economic interests, overall lifestyle, and physical presence (days test). Although subjective, one’s lifestyle and the location of family and economic ties are the critical determinants of an individual’s CoL and tax residency status.
The days test is a secondary factor that may also determine tax residency. Under this test, an individual may be considered a tax resident of Israel if either of the following conditions are met:
It is important to note that an individual can still be deemed a tax resident of Israel even if they do not meet the days test if the CoL is still deemed to be in Israel when considering all facts and circumstances.
Why does residency matter?
The determination of residency is critical because Israel subjects its tax residents to tax on worldwide income, regardless of where they are physically located. Non-residents, on the other hand, are taxed only on Israeli-source income. With a top income tax rate, including surtax, of 50%, there can be a significant amount of additional tax due for someone who is unable to break residency upon their departure from Israel.
Employees who retain their tax residency in Israel are responsible for filing an annual tax return to report worldwide income. Failure to do so can result in serious financial and legal ramifications and is considered as a criminal offense.
Although the current enforcement initiative is specific for relocations to Cyprus, the focus on residency status for departing Israelis is not new. A high profile example occurred in 2020 when Bar Refaeli, an internationally known model and television host, and her mother were convicted of tax evasion by an Israeli court.
The case focused on Refaeli’s Israeli tax residence during years when she traveled around the world as a model. In the end, the court disagreed with her position that her CoL had been disconnected and sentenced her to pay millions in fines and back taxes, as well as nine months of community service.
And it’s not difficult to find fact patterns that reflect the challenges of disconnecting the CoL for Israeli tax purposes:
David, an Israeli citizen, travels extensively for work. Although he spends most of his time abroad, he maintains a permanent home in Israel and visits frequently. His CoL remains tied to Israel due to his family, economic interests, and social connections.
Rachel relocates to the United States but continues to own property in Israel. She spends significant time in both countries, leading to dual residency. Despite her efforts to disconnect, the Israeli tax authorities still consider her a resident due to her substantial ties.
Avi runs a successful business in Israel. Even after moving to another country, he remains actively involved in managing the business. His economic interests and professional connections keep his CoL anchored in Israel.
As the rules and examples clearly show, the critical requirement in avoiding potential tax and legal issues when relocating from Israel is the proactive disconnection of the CoL before departure. Here are key steps to achieve this objective:
Relocating from Israel involves more than just packing boxes and booking flights. It requires careful consideration of tax implications, particularly regarding the concept of the CoL.
Remember that each case is unique, and tax residency depends on various factors. By understanding the rules, strategically planning the disconnection from Israel's CoL, and seeking professional guidance, individuals can navigate the process effectively while ensuring compliance with relevant tax regulations.
If your company or employees are facing challenges related to Israeli tax residency during relocation, our experienced team is here to help. We understand the complexities involved in disconnecting one's Center of Life and ensuring full compliance with Israeli tax regulations. Don't hesitate to schedule a consultation call with our advisors, who can provide personalized guidance and strategies tailored to your unique situation.