1. The Israeli tax system and tax benefits for foreign residents Ran Artzi, CPA (Isr). Lilach Asherov-Rubin, Adv.

2. The Israeli tax system

3. 3 The Israeli tax system - General As of 2003, income Tax in Israel is levied based on a personal method. Accordingly, Israeli residents are liable to tax in respect of their income worldwide. Foreign residents are also liable to tax in Israel with respect to income generated or derived therein (according to source rules) and subject to conventions for prevention of double taxation between Israel and the relevant countries.

4. 4 Israeli resident - Individuals An individual is considered an Israeli resident if his “center of life” is located therein; in this regard, the following considerations are observed : location of his permanent home (individual & family members). Location of his economic and social connections. Location of his permanent or usual employment/ business activity. Location of his active and substantive economic interests.

5. 5 Israeli resident - Individuals The Israeli law sets 2 legal presumptions - an individual's “center of life” is located in Israel in the following cases:  During the tax year he was present in Israel for 183 days or more, or -  During the tax year he was present in Israel for 30 days or more, and his total presence in Israel during that year and 2 previous years amounts to 425 days or more.

6. 6 Israeli resident - an Entity A person other than an individual is considered an Israeli resident if either one of the following is met: It was incorporated in Israel. the “control and management” over its business is exercised within Israel.

7. Income tax rates for Individuals

8. 8 General Regular income of individuals is taxed, Current to 2007, at the following rates (applied to annual gross income): 0 - 133,680 nis - 30%. (31,760$) 133,681 - 192,000 nis - 35%. (31,761$ - 45,616$) 192,001 - 413,400 nis - 36%.(45,617$ - 98,218$) above 413,401 nis - 48%. (98,219$)

9. 9 Gradual decrease of rates Tax rates will gradually decline until 2010. marginal rate will be set to 44%. To this end, overall tax rate is inclusive of social security and health tax payments.

10. 10 Rental income from Israel Tax exemption for rental income from apartments in Israel up to 4,200 nis (1,000 $) per month. The income tax liability on apartments rental fees is calculated on the basis of one of the following alternatives: Rental income is calculated after deduction of expenses and taxed as business income (progressive) tax rates - over 30% rate. Tax is payable at the rate of 10% of gross rental income (without deducting expenses).

11. 11 Overseas Rental income The tax liability of an Israeli resident individual with respect to rental income from real property located outside of Israel, is determined on the basis of one of the following: progressive tax rates applied to net rental income (deduction of permissible expenses). FTC is allowed. flat rate of 15% on rental fees after deduction of only depreciation expenses. other expenses incurred in generating the rental income are not deductible. FTC is denied.

12. 12 Passive Investment Income - flat rates Dividend income - 20% or 25% for an individual who is a “substantial shareholder” (10% or more). 15% - dividend distributed out of the profits of an “approved enterprise” under law of encouragement. Capital gains - 20% or 25% for an individual who is a “substantial shareholder”. However, capital gain from assets acquired prior to 1.1.2003 are allocated - on a linear basis - * part of gain attributed to the period prior to 31.12.02 - general tax rates. * part attributed thereafter - 20%/25%. Interest income - 20% (15% - unlinked assets), except for a “substantial shareholder”.

13. 13 Taxation of Employee Stock Options Plans - (ESOPs) Generally, the income derived from ESOPs may be taxed as ordinary income. Subject to certain conditions, there is a possibility to grant ESOPs, the gain from which will be taxed as capital gain to the employee. The employer is denied the wages expense. The tax is levied only when the option or the proceeds deriving from it are actually transferred to the employee.

14. 14 Personal Credit Points Israeli resident individual taxpayers are awarded personal tax credit points that are offset against the income tax payable. For 2007, each credit point equals 2,136 nis (509 $) per year. A taxpayer’s entitlement to credit points generally depends on personal and family circumstances. For example: A male Israeli resident is awarded 2.25 points. A female Israeli resident is awarded 2.75 points

15. Income tax rates for Companies

16. 16 Corporate tax rates: 2007 - 29%. 2008 - 27%. 2009 - 26%. 2010 (and on) - 25%. Lower rates may apply under law for encouragement of capital investments. Capital gains: 25%. Assets acquired prior to 1.1.2003 - linear allocation - general tax rate/25%.

17. 17 Accumulated Profits At the sale of shares (including liquidation of a company), a tax benefit is granted on gains liable to tax on the corporate level. The part of the gain in the amount of the said profits accrued up to 31.12.2002 is liable to tax at 10% rate. Profits accrued after 31.12.2002 is liable to tax at 20% or 25% rate for individuals, and 0% for companies.

18. 18 Losses Losses arising from a trade or business may be set off, in the year in which they arise, against income from any source. the balance of such losses, if any, will be carried forward, without time limitation, to offset income from a trade or business, as well as business capital gains and land appreciation, but not income from other sources. Tax losses cannot be carried backwards.

19. 19 Setting-off foreign losses Foreign losses are generally set off against foreign income. Passive losses from may set off passive income, and business or vocation losses may set off likewise income; Exception: excess loss from foreign business of which control and management are exercised from Israel, may be set off against income accrued or derived in Israel that year. Capital loss from sale of an asset abroad: shall be set off first against foreign capital gain. Precondition for off setting losses - had it been income it was subject to tax in Israel.

20. Controlled Foreign Corporation (CFC)

21. 21 CFC - General The CFC legislation – Article 75B of ITO - is designed to prevent the deferment or avoidance of taxes through the use of foreign corporations, with respect to passive income. According to the legislation, an Israeli resident who has control over a controlled-foreign-corporation, is subject to tax on his pro-rata portion of that corporation’s “undistributed profits” as though they were actually distributed to him as dividends at the end of tax year - Deemed dividend.

22. 22 CFC - A Controlling Member  The rules set in article 75b apply to an Israeli resident who is “a controlling member”.  A controlling member is a person that holds, directly or indirectly, by himself or jointly, at least 10% of any “means of control” of the corporation at either one of the relevant dates.

23. 23 CFC - definitions A “controlled foreign corporation” is a Foreign resident body-of-persons that meets the following:  Its shares or other interests are not traded on a stock exchange.  Most of its income or profits during the tax year are passive. In this regard, a specific rule is set for a corporation held by a business company.  The tax applied to its passive income overseas does not exceed 20%.  More than 50% of any of the corporate’s “means of control” are held, directly or indirectly, by Israeli residents. In this regard, other alternatives are set by the law.

24. 24 CFC - Definitions “Passive Income” - an income being one of the following, except if it is of a business nature:  Interest or linkage differences.  Dividends.  Royalties.  Rental income.  Consideration for the sale of an asset which was not used as part as the corporation’s business.

25. 25 CFC - Definitions “Undistributed Profits”: Profits originating in passive income of the company, except for profits originating from dividends received from another foreign corporation whose income was taxed at a rate that exceeds 20%, that were not paid to shareholders during the tax year  The profits are calculated according to domestic tax laws of the foreign company’s state of residence, except if it is not a “treaty country“, in which case the profits will be calculated according to accounting principles accepted in Israel.

26. 26 CFC - prevention of double taxation Upon actual distribution of the cfc’s profits to its shareholders, or upon the sale of its shares, tax previously paid by a shareholder for such undistributed profits will be credited against tax due in connection with the distribution or sale, as the case may be.

27. Foreign Vocation Company (FVC)

28. 28 Foreign Vocation Company A foreign body-of-persons that meets all the following:  If it is a company, not more than 5 individuals control the company.  75% or more of any “means of control” are held, directly or indirectly, by Israeli resident individuals.  Most of the controlling members or their relatives, carry on “a special vocation” on behalf of the corporation.

29. 29 Foreign Vocation Company  Most of its income or profits derive from “a special vocation”.  Income generated by FVC from activities preformed by a controlling members (through his relative or a company under his control) shall be taxed in Israel as income generated in Israel.  The FVC is considered an Israeli resident for domestic tax purposes.

30. 30 Rules for Foreign Tax Credit (FTC) FTC is granted to Israeli residents only with respect to their income generated outside Israel (according to Israeli source rules). Foreign taxes may offset Israeli tax levied on the same income, while separating different types of income - the “basket method”. In this regard, all income of the same type generated in all countries except Israel are grouped into one basket (e.g. dividend basket; business income basket etc.). Cross-credit within a basket is permitted.

31. 31 Rules for Foreign Tax Credit (FTC) No credit is granted for income exempt from tax in Israel. excess foreign tax may be carried forward up to 5 years (within a basket) and will be index-adjusted.

32. 32 Exit tax An Israeli resident that ceases to be an Israeli resident is treated as if he sold all of his assets on the day before he ceased to be an Israeli resident. Payment of tax may be postponed until the day on which the asset is disposed of. In case the disposition price is lower than the value of the asset on the day in which the taxpayer ceases to be an Israeli resident, the lower value applies. The exit tax is not imposed in to assets which remain subject to Israeli tax.

33. Real estate taxation

34. 34 Land betterment tax The Land betterment tax is levied on gain derived from: Sale and any kind of transfer of real estate located in Israel; Disposition of shares or other interests in a “Real Estate Company” (a body-of-persons whose entire assets comprise of interests in real estate located in Israel, except for accessory assets). Tax rate for land betterment accrued after 7.11.2001 is 20% for individuals and 25% for companies. For land betterment accrued before that day - marginal rates for individuals and companies rate for companies.

35. 35 Land betterment tax The sale of a residential apartment by individuals is exempt from land betterment tax if certain conditions are fulfilled. Exemption from land betterment tax is granted for certain types of transactions (e.g. a gift between individual family members).

36. 36 Acquisition tax Real estate purchased in Israel is subject to acquisition tax payable by the buyer. Generally, 5% tax rate is imposed on the value of real estate. For a residential apartment, the acquisition tax is calculated based on purchase price as follows (if certain conditions have been fulfilled): Up to 476,215 nis (113,385 $) - 0.5%. From 476,215 nis (113,385 $) until 739,120 nis (175,980 $) - 3.5%. Above 739,120 nis (175,980 $) - 5%.

37. Value added tax (vat)

38. 38 Value added tax Value added tax (Vat) is levied on the consumption of goods and services in Israel. Vat is indirect tax, levied goods delivered and services rendered in Israel. The current vat rate in Israel is 15.5% for all taxable transaction. Transactions subject to 0% Vat rate (examples): Exported goods. Sale of intangible assets to non residents. Services rendered outside Israel to non resident.

39. Social security

40. 40 Social security Employers, employees and self-employed are liable for social security payments. The employee’s share includes compulsory health insurance. The social security rates are based on gross monthly income, as follows (current to 2007): Employee’s share: 3.5% for 3,580-4,522 nis (852- 1,076 $) gross income, and 12% for 4,522-35,760 nis (1,076-8,514 $) gross income. Employer’s share: 4.14% for 3,580-4,522 nis (852-1,076 $) gross income, and 5.68% for 4,522- 35,760 nis (1,076-8,514 $) gross income.

41. Tax benefits for foreign residents

42. 42 general overview Israel encourages investments from both Israeli and foreign residents, by offering a wide range of incentives and benefits through a number of laws and regulations. In order to promote weak economic regions within Israel, certain benefits are granted in a differential manner - greater benefits in “priority regions” (A, B) than in the center of the country. However, enterprises throughout the country may be eligible for benefits if they comply with the relevant criteria.

43. 43 general overview Special emphasis is given to high-tech industries and R&D activities. Specific tax benefits are designated for foreign residents designed mainly to promote investment in Israeli capital market (including banks). Increased tax benefits for companies with greater “foreign participation” under the Law for Encouragement of Capital Investment. special anti abuse section to prevent “Israelis” from abusing such benefits - art. 68A.

44. 44 Categories of exemptions & benefits Exemption from tax on capital gains; Exemption from tax on investment income; Law for Encouragement of Capital Investment from 1959; Participation Exemption; Taxation of Trusts; Sec 16A of Income Tax Ordinance.

45. 45 Exemption for capital gains Gain derived from the sale of securities traded in Israeli stock exchange, provided the gain was not derived within a permanent establishment of the seller located in Israel. Gain derived from the sale of Israeli resident company’s securities traded in a foreign stock exchange, provided the gain was not derived within a permanent establishment of the seller located in Israel, the security was purchased after registration for trade and other conditions.

46. 46 Exemption for capital gains Gain derived from the sale of shares in an Israeli resident company who - at the time of issuance of such shares - was approved as an “R & D Company”.

47. 47 Special exemption to boost investments - Art. 97(B3) Special exemption from CG in relation to investments in Israeli resident companies (or foreign companies whose main assets are interests in Israeli assets) between 1.7.05 and 31.12.08. The exemption is excluded for: Gain derived within a PE of the seller in Israel. Gain derived from the sale of any security of a company which - at the acquisition date of that security and two years preceding its sale - the major value of its assets comprised of interests in real estate located in Israel or in an Israeli real estate company.

48. 48 Special exemption to boost investments Conditions at the acquisition date: Acquisition between 1.7.05 - 31.12.08. Acquisition for “Fair Value” consideration. The purchaser was a resident of a country with which Israel had a convention for the avoidance of double taxation (treaty country), as follows: An individual purchaser - was a resident of a treaty country for at least 10 years prior to acquisition; A foreign entity purchaser - at least 75% of “controlling interests” over such entity were held, directly or indirectly, by individuals who were residents of a treaty country for at least 10 years prior to acquisition.

49. 49 Special exemption to boost investments An acquisition statement was filed with Israeli tax authority within 30 days of acquisition. Conditions at the selling date : The seller is a resident of a treaty country; The seller reported the sale to the tax authorities of country of which he is a resident. The seller filed a request to be exempt from tax to Israeli tax authorities. The exemption is not conditioned upon the date of selling.

50. 50 Exemption for interest on a “Foreign- Currency-Deposit” Interest paid to a foreign resident for a non-NIS deposit in an Israeli bank is exempt, provided all the following conditions are met: The deposit is not within a PE located in Israel and the income does not derive from business activity. No Israeli residents share interests in the deposit. “a foreign resident statement” was filed. The deposit has not secured a loan granted by the bank to an Israeli resident, who is a relative of the owner (a family member or controlled corporate).

51. 51 Exemption for income / gain from government bonds or loans Interest (including discount) or index-linkage differentials paid on a government bond or loan traded in Israeli stock exchange; Capital gain derived from the sale of such government bond or loan not traded on stock exchange (in Israel or overseas); Exempted provided that: The tax payer was a foreign resident at the date of the bond/loan’s acquisition and/or at the date of its sale. The income/gain from the bond/loan are not within his PE located in Israel.

52. 52 Investment income in Israeli capital market - foreign residents mutual fund Exemption from tax for a foreign resident mutual fund: CG from sale of securities listed for trade in Israeli stock exchange, if acquired following listing or from the sale of foreign securities. Interest & currency differentials for foreign- currency deposit in Israel. Dividend, interest & currency differentials derived from foreign securities.

53. 53 Exemption for investment income Currency differentials on a loan granted by a foreign resident, provided that it was not granted through his PE in Israel. currency differentials on a company’s foreign currency bank deposit originating from a foreign resident's payment for such company’s shares, provided the company is mainly controlled by foreign residents.

54. 54 Exemption for interest income Interest paid by an Israeli body-of-persons to a foreign resident in relation to a foreign currency loan granted by him provided it is used for a purpose included in the Law for Encouragement of Capital Investment. The exemption from tax (wholly or partly) requires the approval of the Minister of Finance.

55. 55 Article 16A of ITO The Minister of Finance is authorized to return income tax, fully or partly, to a foreign resident if the tax payable in Israel is not granted to his as a credit against the tax due in his state of residence.

56. Investment incentives and trade advantages

57. 57 Law for Encouragement of capital investments, 1959 (“the law”) A special status of an “approved enterprise” or “program” may be awarded to investments (domestic and foreign) and activities (mainly industrial) in Israel. This status awards income tax benefits (current business income & dividend distributed) and/or government grants. The law applies to industrial enterprises (including high-tech and bio-tech), hotels and other tourist ventures, industrial and residential buildings. It may also apply to industrial development centers located in Israel.

58. 58 Encouragement of capital investments In recent years, the law has undergone comprehensive amendments. Presently, 3 “routes” of tax benefits are available to enterprises located in preferred region A: A scheme allowing tax exemptions during the concession period. The company tax is, wholly or partially, deferred until distribution of untaxed profits, at which time it will be paid by the company. Lower withholding tax rate in respect of dividends distributed - 15%, or lower according to a tax treaty.

59. 59 Encouragement of capital investments The scheme known as the “Ireland Scheme” - The profits are taxed at the rate of 11.5%. No additional company tax is required when profits are distributed. Withholding tax rate in respect of the dividends distributed from such profits - 15% for Israeli residents shareholders and 4% for foreign residents.

60. 60 Encouragement of capital investments A strategic investments scheme - The enterprise is granted a full tax exemption during the concession period and is not required to pay additional tax upon distribution of profits as dividends. No tax withholding from dividends. A minimum threshold of investment amount - between 147$ - 220$US million (depending on location).

61. 61 The approval requirement An enterprise seeking grants is required to submit a plan to the Investments Center. An enterprise wishing to benefit from tax concessions is no longer required to file a formal request. Provided it complies with the conditions stipulated by the law, it is eligible for such tax benefits and may claim them under the income tax returns it files.

62. 62 General requirements Under the grants scheme, the enterprise is required to fund 30% of the scope of approved investments in equity. No such requirement exists for the tax benefits schemes. For investors defined as “foreign residents”, the state provides increased tax benefits which they are able to enjoy for longer periods.

63. 63 Tax benefits period for grants scheme Tax benefits for an approved enterprise are granted for a period of 7 consecutive years and may be extended, under certain conditions, up to 10 years for foreign invested companies.

64. 64 Approved enterprise controlled by foreign residents The reduced tax rates are in accordance with the percentage of foreign participation, as follows: (1) 15% of the balance for approved enterprise, 25% otherwise. Taxes may differ for residents of countries that have tax treaties with Israel. Not an approve d enterpris e An approved enterprise - % of foreign participation 0-4949-7474-89 90- 100 Taxable income 100 Corporate tax 29 2520 15 10 Balance 71 7580 85 90 Tax on distributed dividends 17.7511.251212.7513.5 Total tax burden46.7536.253227.7523.5

65. 65 “A foreign-invested company” In order to be consider as an “approved enterprise controlled by foreign residents”, certain conditions have to be fulfilled: the foreign residents must invest at least 5 million NIS (1.2 million $) in the company’s capital stock, including shareholder loans, such investment providing a right to its capital stock, profits, voting power and managers nomination. Foreign resident who purchased a company whose paid-up capital stock exceeds 5 million NIS.

66. 66 “A foreign-invested company” A company controlled by an Israeli resident, directly or indirectly, or a company that Israeli residents are eligible to 25% of its profits, will not be considered as an enterprise controlled by foreign residents.

67. 67 Tax benefits for “exempt enterprise” (non-grants scheme) The enterprise must be an industrial plant or hotel. The Enterprise is competitive and contributes to the gross domestic product. (An enterprise will be considered to have fulfilled this condition, for example, if it is engaged in bio technology or nanotechnology and has obtained the approval of the head of industrial R&D administration, or if it exports at least 25% of his yearly income). Minimum investment in capital assets/equipment, as described below.

68. 68 The minimal amount of investment New investment - at least 300,000 nis (71,430 $). Expansion of an existing enterprise - a percentage of the value of productive assets, as follows:  Up to 140 million nis (3.33 million $) - 12%.  Above 140 million nis (3.33 million $) and up to 500 million nis (119 million $) - 7%.  Above 500 million nis (119 million $) - 5%. Provided that the total amount of investment will not be less than 300,000 nis.

69. 69 Tax exemption (deferral) until profit distribution A company may choose an alternative benefit scheme allowing it tax exemptions instead of grants. Only limited liability companies are entitled to choose this scheme. This periods for tax benefits are as follows (years): (1) On the undistributed portion only. (2) The reduced tax rates are identical to the rates details above. National priority region ABC Tax exemption (1) Reduce d taxes (2) Tax exemptio n (1) Reduce d taxes (2) Tax exemptio n (1) Reduced taxes (2) Domestic company 10-6125 Over 25% foreign control 10-6428

70. 70 Tax exemptions until profit distribution Companies in which foreign participation exceeds 74%,(and with approved program not less 20 million $) are entitled to a longer benefit period (15 years), subject to the approval of the investment center board. The tax exemption is actually a tax deferment. The exempted tax becomes due when the enterprise distributes tax exempted profits.

71. 71 Accelerated depreciation Approved enterprises are eligible for accelerated depreciation on the tangible assets, reaching 400% of standard depreciation rates on buildings (not exceeding 20% per annum and exclusive of land), and 200% on equipment. The tax authorities may allow increased rates of up to 250%, if there is evidence of a high depreciation rate of equipment. This benefit is available for a 5 tears period from date of operation rather than from purchase date of asset.

72. Participation exemption

73. 73 Participation Exemption A recent legislation (in force as of 1.1.2006) provides for a participation exemption regime for Israeli holding companies, under specific conditions. An Israeli holding company is exempted from tax on the following: (1) dividends received from foreign subsidiaries; (2) capital gains tax upon sale of such subsidiaries; (3) interest on bank deposits in Israel and on income (interest, dividends, and capital gains) from securities traded in Israeli stock exchange.

74. 74 Participation Exemption - benefits for foreign investors Foreign shareholders benefit from a reduced withholding rate on dividends distributed by the Israeli holding company - 5%. Foreign shareholders may apply for tax exemption on capital gain upon the sale of the Israeli holding company’s share under Art. 97(B3) - special exemption.

75. 75 Participation Exemption Israeli residen t Foreign resident Israeli holding company

76. 76 Participation exemption Definitions: “Israeli holding company” Registers in Israel, Managed and control from Israel. The company is privately owned and not tax transparent. The company is not a financial institution. Its total investment in foreign subsidiaries, throughout at least 300 days of the tax year, amounts to at least 50 million NIS (11.9 million $). 75% or more of its assets constitute the subsidiaries. The company formally requests to be recognized as a holding company.

77. 77 Participation exemption “Subsidiary” for participation exemption: Resident of a treaty country. Resident in non treaty country - provided that the corporate tax rate on business income in that country is 15% or more (at time the shares are purchased). The Israeli holding company holds at least 10% of profit rights in the subsidiary for 12 consecutive months. At least 75% of the subsidiary’s income from sources outside Israel business income. Israeli assets or Israeli income of the subsidiary may not comprise more than 20% of the subsidiary’s total assets/income, respectively.

78. Taxation of Trusts

79. 79 Foreign Resident - Settlor trust The “Foreign Resident Settlor Trust” classified as such under recent legislation (in force as of 1.1.2006), may be used as an instrument for international tax planning. A trust is considered a “Foreign resident settlor trust” if - at the time of its establishment, and during the relevant tax year, all its settlors are foreign residents (irrespective of the beneficiaries’ tax residency); Or- during the relevant tax year, all its settlors and beneficiaries are foreign residents. irrevocable or not.

80. 80 Foreign Resident Settlor trust The transfer of assets by the settlor to the trustee is not taxable; The trustee’s income is taxable as if it were the foreign resident's income. Income generated outside Israel is not taxable nor does it need to be reported in Israel. Transfer of assets from the trustee to the beneficiaries is regarded as being transferred to them by the settlor directly.

81. 81 Foreign Resident Beneficiary Trust “Foreign resident Beneficiary trust” - At least one of its settlors, at the time it was established, was an Israeli residents; The trust is irrevocable; All the beneficiary during the relevant tax year are identified foreign residents.

82. Tax treaties

83. 83 Treaties for prevention of double taxation Israel has entered into tax treaties with 42 countries, most of them are based on the OECD model convention. In addition, two treaties have been ratified and will enter into force as of January 1, 2008.

84. 84