02 Apr 2011
The publication of the Finance Bill yesterday also coincided with other announcements from HMRC on issues affecting residency which will have wide ranging effects. Perhaps the most significant announcement indicated that HMRC would challenge the residency position on non UK residents if they were to spend more than 10 days working back in the UK during a year, potentially subjecting their entire income to UK tax. A great many individuals who have considered themselves to be non resident for a number of years may find their residency positioned challenged.
Sean Drury, international mobility partner at PwC commented:
“Ten days is an extremely low figure and will severely restrict multinational corporations in conducting trade. Particular concerns would be raised where expats are working in jurisdictions with low or no tax such as the emerging and growth economies of the Middle East and South East Asia.”
Expats may also be hit by changes to the tax treatment of their pensions. In line with the disguised remuneration rules, HMRC yesterday announced changes to Extra Statutory Concession A10.
Ben Wilkins, international mobility adviser at PwC, commented:
“Although little known outside of the tax profession, ESC A10 has been a bedrock concession for pensions for years and allows relief for individuals who have worked the majority of their life overseas. The proposed changes to this concession will bring into the scope of tax pensions accruing from 6 April 2011. These may not have previously been taxed in the UK. We will be closely following the detail over the forthcoming weeks.”
Sean Drury, international mobility partner at PwC added:
“There has been more change to the fundamental principles of domicile and residency in the last four years, especially in HMRC interpretation, than in the previous 40. I seriously question whether all these changes have improved the position of the United Kingdom from either a revenue or economic perspective. We welcome the possibility of a statutory residency test to the extent it is clear, equitable and enhances rather than hinders expatriation and the flow of trade.”
(Reprinted from the UK media center of the Price Waterhouse website.)
“Each year, in the United States alone, offshore tax evasion produces an estimated $100 billion in unpaid taxes that could help pay for health care, education, and more. It’s time to put an end to offshore tax dodging that robs the U.S. Treasury of needed funds.” —Statement of Senators Carl Levin (D-Mich.) Norm Coleman (R-Minn.), March 6, 2008.
All U.S. Persons are subject US taxation on their worldwide income. The threshold question is whether the taxpayer is a U.S. Person. A U.S. Person is generally defined as a U.S. citizen or resident or domestic entity (corporation, partnership, estate, trust). IRC §7701(a)(30).
There are two types of U.S. residents. The first type is the lawful permanent resident, which is a foreign person who has received a U.S. green card. The second type is the substantially present resident. This is a person who is present in the United States for 183 days either (1) during the current year, or (2) over 122 days per year, over the past three years based on the following formula: (A) number of days present during the current year, plus (B) number of days present in prior year multiplied by 1/3, plus (C) number of days present two years ago multiplied by 1/6.
For taxpayers who disclaimed their U.S. citizenship or terminated their residency, they are subject to foreign-interest reporting rules. Regardless of their status under immigration law, a taxpayer is still treated as a U.S. citizen or resident for tax purposes until proper notice is given to both the Department of State (or Homeland Security) and the IRS.
Many U.S. Persons living in Israel are holding bank accounts or other financial accounts without reporting these funds to the Internal Revenue Service (IRS). The US tax net is closing down on US taxpayers all over the world starting in Switzerland but also in Israel. In the coming months, Israeli banks like most financial institutions worldwide, will be signing an agreement with the IRS to disclose bank transaction of U.S. Persons. In this regard one should plan his or her financial position accordingly and not be caught unprepared.
On February 8, 2011, The IRS announced a special voluntary disclosure initiative designed to help ensure that funds held worldwide are brought into the US tax system and help individuals with undisclosed income from hidden offshore financial accounts get current with their taxes.
The IRS decision to open a second special disclosure initiative follows continuing interest from taxpayers with foreign accounts. The first voluntary disclosure program ended with 15,000 voluntary disclosures on October 15, 2009.
The new voluntary disclosure initiative, called the 2011 Offshore Voluntary Disclosure Initiative (OVDI), allows individuals with previously unreported foreign financial accounts to significantly reduce their exposure to substantial civil tax penalties and, in many cases, to eliminate the potential of criminal prosecution. This program will only be available through August 31, 2011.
The OVDI program requires individuals to pay a penalty of 25% of the amount in their foreign bank accounts for the year with the highest aggregate account balance – from 2003 to 2010. Participants must also pay back taxes and interest for up to eight years as well as paying accuracy-related and/or delinquency penalties.
In limited situations, taxpayers can qualify for a five percent penalty.
The IRS also created a new penalty category of 12.5% for addressing smaller offshore accounts. Individuals whose offshore accounts or assets did not surpass USD$75,000 in any calendar year covered by the OVDI program will qualify for this lower rate.
The OVDI program offers clear benefits to encourage taxpayers to reconcile their tax issues rather than risk IRS detection. Taxpayers hiding assets offshore who do not come forward will face far higher penalty scenarios including a 50% of the balanced account penalty for every year that an FBAR (Foreign Bank and Financial Accounts) has not been reported as well as many other penalties (the IRS gives an example of an uncovered, unreported foreign account with USD$1.05 million – USD$1.4 million between the years 2003 and 2010 that will face USD$4,543,000 in tax and penalties if the taxpayer did not come forward within the program parameters) and the possibility of criminal prosecution.
In this regard, it should be mentioned that according to the Foreign Account Tax Compliance Act (FACTA), which was enacted on March 18, 2010, foreign financial institutions (FFIs) are required to deduct and withhold a tax equal to 30% of the amount of any payment to an FFI unless the FFI agrees to disclose the identity of the U.S. Persons and report on their bank transactions. In this regard the Israeli banks will not take the risk of 30% withholding on US investments so that one should assume that they will enter the FACTA arrangement and will disclose information on U.S. Persons with bank accounts in Israel.
Taxpayers participating in OVDI program must file all original and amended tax returns and include payment for taxes, interest and accuracy-related penalties by the August 31, 2011 deadline.
It is also worth noting that once the IRS begins an investigation concerning a U.S. Person’s assets in Israel, it may cause compliance complications for that individual in Israel as well. The IRS’s reciprocal information exchange arrangement with the Israeli tax authorities often leads to information being passed on to the Israeli tax authorities regarding funds being held in the US by that same individual. Needless to say, if those funds were not reported in Israel, the Israeli tax authorities will take issue.
On December 17, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the “Act”). In addition to extending the Bush income tax cuts until December 31, 2012, the Act contains numerous changes to the federal estate, gift and generation-skipping transfer (GST) tax laws, which also will expire on December 31, 2012. Below is a summary of the estate, gift and GST tax provisions included in the Act. It is important to note that one change in particular – namely, the elimination of any GST tax on certain 2010 transfers – may require action before year-end, as discussed more fully below.
1. Reinstatement of Estate Tax
The Act reinstates the federal estate tax for decedents dying after December 31, 2009, with a lower 35% maximum tax rate, and with a higher $5 million federal estate tax exemption than originally scheduled. For individuals who died this year and who do not “opt out” of the estate tax (more on that below), the estate tax is applied retroactively; and estate tax returns are due by September 17, 2011. The Act also repeals the modified carryover basis rules for 2010 (except for estates that opt out of the federal estate tax) and implements the familiar “step-up” in basis regime that existed prior to 2010.
Opt-Out Provisions for 2010 Decedents
The personal representative of the estate of a 2010 decedent has the option to “opt out” of the imposition of federal estate tax. If opting out is elected, the basis of the decedent’s assets will be determined under the modified carryover basis rules in effect for 2010, with a basis step-up of approximately $1.3 million for nonspousal transfers and a basis step-up of $3 million for certain spousal transfers.
Before electing to opt out of the federal estate tax in 2010, however, the personal representative of a 2010 decedent’s estate should consider the changes in the basis rules and how they might affect the basis of assets transferred to beneficiaries. If the taxable estate is $5 million or less, the personal representative probably would not want to opt out of the federal estate tax in 2010, since under that regime, the estate would obtain a full basis step-up with no federal estate tax. Other situations may require consultation with a tax professional in order to weigh the benefits of obtaining a full basis step-up under the federal estate tax regime or having a zero federal estate tax under the opt-out regime.
2. Portability of Estate Tax Exemption
The Act introduces the concept of “portability” to the estate tax exemption, giving the surviving spouse’s estate the ability to use any unused estate tax exemption remaining at the death of the first spouse. Under the Act, a surviving spouse will benefit from the portability provision only after 2010. Nevertheless, while the portability provision is designed to protect the use of each spouse’s exemption, there may be tax benefits to continuing to plan specifically for this, as before. Thus, as with other provisions of the Act, individuals may wish to consult with a tax professional before deciding whether or not to rely on the new provision.
3. Gift Tax Exemption Increase to $5 Million
The Act gives donors a $5 million gift tax exemption, adjusted for inflation, for 2011 and 2012. The gift tax exemption remains at $1 million in 2010. The maximum gift tax rate will also be 35%. Any gift tax exemption used during an individual’s lifetime will decrease the $5 million federal estate tax exemption available under the Act. Individuals contemplating year-end gifts may want to consult with a tax professional to determine whether it would be preferable to complete any gifts in 2010 or postpone them until 2011 to take advantage of the increased gift tax exemption.
4. GST Tax Exemption Increase to $5 Million and 2010 Year-End Planning Opportunities
The Act reinstates the GST tax and increases the GST tax exemption to $5 million, beginning in 2010. It appears that the $5 million exemption will be available for all 2010 decedents’ estates, regardless of whether an estate has opted out of the federal estate tax. The GST tax rate is zero for 2010 and 35% in 2011 and 2012.
With the zero GST tax rate in 2010, several planning opportunities may be available if completed by year-end. First, individuals contemplating gifts to grandchildren or more-remote descendants may want to make outright gifts to such individuals before year-end and incur no GST tax, provided such gifts can be shielded by the donor’s available gift tax exemption (again, $1 million in 2010).
Second, funding trusts for grandchildren and more-remote descendants can be beneficial under the Act if completed by year-end by eliminating GST tax on certain future transfers. Finally, certain trust distributions can be made to grandchildren and more-remote descendants free of GST tax, again provided the distributions are completed by year-end.
The ability to structure transfers this year to eliminate or minimize GST tax can be a significant planning tool, and individuals may wish to consult with legal counsel before year-end to discuss this opportunity.
5. Traditional Planning Techniques
Equally key to what is in the Act is what is not in the Act. Valuation discounts are often used with various estate planning techniques (such as family limited partnerships). While it had been rumored that the new tax law would limit the ability to discount the value of assets in estate planning transactions, the Act does not include such limits. As a result, valuation discount planning continues to be an effective estate planning tool, and individuals may want to take advantage of such techniques, in case Congress limits such planning in the future.
In addition, prior legislative proposals would have instituted a minimum ten-year term for an estate planning technique known as a “Grantor Retained Annuity Trust” (“GRAT”), which would have greatly reduced the planning opportunities associated with this type of trust. However, no such provision is included in the Act. Short-term GRATs (e.g., two to three years) appear likely to be viable, at least in the immediate future. As a result, the rush to create GRATs prior to 2011 has eased. Nevertheless, GRATs can be particularly effective when interest rates are low, and with the current applicable rate at its lowest point ever recorded (1.8% in December 2010), there appear to be good reasons to establish a GRAT now.
The above information was reprinted with permission from DuaneMorris attorneys. As required by United States Treasury Regulations, the reader should be aware that this communication is not intended by the sender to be used, and it cannot be used, for the purpose of avoiding penalties under United States federal tax laws.
Disclaimer: This alert has been prepared and published for informational purposes only and is not offered, or should be construed, as legal advice. For more information, please see the firm’s full disclaimer.
A recent enquiry made to the Canada Revenue Agency (CRA) involved two questions with respect to the timing and amount of a charitable gift made in an individual’s will:
1. How do you claim a gift made by will if the gift is not received by the charity by the due date for filing the deceased’s terminal return?
2. How do you value the gift if the property changes in value between the date of death and the time the property is transferred to the charity?
When a donation is made by will, it is considered to be a donation made immediately before the time of death and, as such, a gift made by the deceased that can be claimed on the terminal tax return. A gift on the terminal tax return generates a tax credit, but only to a maximum of 100 per cent of net income reported on that return. Any gift in excess of this limit can be carried back one year and claimed on the prior tax return, again subject to a limit of 100 per cent of net income. However, from a practical point of view, such a gift may take some time to complete as the executor undertakes to complete an inventory of estate assets and obtain probate of the will.
For gifts completed before the terminal tax return is filed, the executor would include the official receipt from the named charity. For gifts that cannot be completed before the terminal tax return is filed, the CRA has indicated that the executor should claim the appropriate amount in the terminal return and provide a copy of the will, a letter from the estate to the charity advising of the gift, and a letter from the charity acknowledging the gift and its intention to accept the gift to document the gift.
In respect of the second question, the CRA responded that the value of the gift is to be determined at the date of death. Consider the example of an individual who bequeaths 1,000 shares of Public Co in his will to his favourite charity. Although at the time of his death the shares may be worth $50 each, their value may be higher or lower at the time of physical transfer to the charity. The value of the gift will be $50,000 irrespective of the actual value at the time of transfer. This is very important because values will often change between the date of death and the time of transfer.
It should be noted that where the value of the gift cannot be reasonably determined, no charitable gift tax credit will be allowed. This may arise, for example, in situations where the estate may not have sufficient financial resources to pay its liabilities, leaving insufficient assets for specific bequests.
(This article was reprinted with permission from The Institute for Financial Education “Comment”, November – December 2010)
When Olim (or other Israeli residents) receive financial gifts or inheritance bequests from family members living abroad, it is usually expected that any tax associated with the gift will be paid by the grantor and not by the beneficiary. However, this may not be the case.
According to Section 89 of the Israeli Income Tax Ordinance (“the ITO”), an Israeli resident is taxed on capital gains derived by him/her from his/her worldwide assets. Thus, when an Israeli resident acquires rights to an asset located outside of Israel (whether in the form of stocks, bonds, real estate property or the like—regardless of how the asset was acquired), he/she will be taxed on the capital gain earned from this asset at the time that it is sold.
According to Section 88 of the ITO, the figure used to determine the “cost base” of the asset is the original cost of purchasing the asset. That means that capital gain tax is calculated based on the difference between the original purchase price and the amount for which the asset was sold. Accordingly, where an asset is received in the form of a gift or by means of inheritance, the principal rule (with certain exceptions) is that the current seller will be regarded as having “stepped into the shoes” of the grantor or testator (as applicable). As a result, the Israeli resident will be liable to pay tax on a gain which had accrued during a period when he/she was not the owner of the asset.
What is seemingly even more unjust is the potential for double taxation. When the grantor gifts the asset, disposition/gift/estate tax has usually already been paid by the grantor. For example, if an Israeli resident receives a gift of stock from his/her Canadian parent, the parent (or the parent’s estate) will have been deemed to have disposed of the property for tax purposes, and be required to pay the Canadian tax authorities tax on the gain accrued. If the grantor is a US Person, the gift is subject to US gift tax or US estate tax rules. Yet, for the Israeli resident, none of these taxes paid are taken into account.
The bottom line is that the Israel tax legislation does not provide a tax credit for gift, disposition or inheritance tax paid by the grantor. In order to prevent the possibility of double taxation, Israeli residents have only one practical solution — to apply to the Israeli tax authorities for a pre-ruling. The pre-ruling will enable Israeli residents to, inter alia, enjoy a “step up” in the value of the relevant asset and when selling the asset, be taxed only on the gain accrued from the date the gift was received.
In recent years, several pre-rulings have been issued by the Israeli tax authorities in matters similar to the aforementioned scenarios, i.e., where an Israeli resident inherits an asset which is located outside of Israel and where inheritance tax is imposed on the estate in the country of residence of the testator. In such pre-rulings, the Israeli tax authorities have agreed that for Israeli capital gains purposes:
- The date of acquisition of the relevant asset will be deemed to be the date of death of the testator and;
- The cost of the asset will be deemed to be the same value used to determine the inheritance tax imposed on the testator in his/her the country of residence.
It’s important to be aware that the Israeli tax authorities demand that certain conditions be met prior to issuing a pre-ruling, for example:
- If a capital loss arises from the sale of the asset, it will not be set-off against the capital gain derived in Israel and;
- When calculating the capital gain, no foreign expenses (e.g., expenses associated with management of the bequest, amortization, etc.) will be deducted.
In the past, the pre-ruling solution was ambiguous and vague, and the conditions and demands in order to obtain such a ruling were uncertain. Lately the Israeli tax authorities have introduced an improved solution to such cases which is called the “green light approach”. According to the “green light approach” the conditions which must be met in order to obtain such a pre-ruling are clearly publicized. Furthermore, the green light approach defines exactly what information must be submitted by the applicant.
But what about gifts or bequests that did not attract gift/inheritance taxes? The green light approach allows for the possibility of obtaining such a pre-ruling even if no such taxes were paid. An asset market valuation will be required in these cases.
If you are expecting to receive a gift or inheritance from someone abroad, it is recommended that you contact a tax practitioner to examine:
- the likelihood of any possible capital gains tax exposure and;
- if needed, prepare an application to the Israeli tax authorities for the purpose of obtaining a pre-ruling in the green line approach on the basis outlined above.
It is advisable to initiate an examination when the asset is being received, since it will be simplest time to verify the asset’s value for tax purposes.
For more information, please contact:
Chaim Wigoda, Managing Director, HCC International Services Ltd. firstname.lastname@example.org
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Deloitte Israel recently published a report on changes to the Israel Tax Code for immigrants and returning residents. The report discusses corporate taxes, passive income, capital gains tax and many other areas that are of prime importance to potential immigrants and returning residents.
Click the Deloitte icon in the blogroll to read the report.
By LEOR NOUMAN AND CHAIM WIGODA
In 2003, Israel completely overhauled its national taxation program for individual and corporate residents.
As a result of that major tax reform, Israel no longer taxes on a territorial basis but rather on a residential basis. That means that as of January 1, 2003, Israel changed from only taxing its residents on what was earned within its borders, to taxing them on their worldwide income.
For many immigrants, the reform marked the end of an era where one could “have his cake and eat it too”. The reaction was predictable; many are incensed with the changes. Some have even threatened to leave.
But, in reality, Israel’s new tax reform is simply the transition to tax laws prevalent in any Western country. New anti-avoidance rules have been introduced such as the Controlled Foreign Corporation (CFC) and Foreign Occupational Companies (FOC) rules. The new CFC rules apply to foreign companies controlled by Israeli residents and impose a deemed dividend tax on undistributed profits from passive income of the CFC.
By Leor Nouman and Chaim Wigoda
Tel Aviv — Moving to a new country can be stressful; particularly a country with a difference climate, culture and primary language. In an effort to increase aliyah from North American, the Isreali government is taking an active role in improving that situation for potential olim and former Israeli residents.
The number one reason for an unsuccessful aliyah is because of the financial strains placed upon the oleh.
To battle the financial strains, the Knesset ratified a new law on September 16, 2008. Back-dated to 2007, olim and returning residents (people who lived abroad for more than 10 consecutive years) now have several new entitlements available to them.