Moran Harari ■ Tax Justice Network Israel publishes three new policy papers on taxing capital gains in Israel
On 21 May 2019, Tax Justice Network Israel, in collaboration with Friedreich Ebert Stiftung (FES) Israel, organised three parallel roundtables in the College of Management related to taxing capital income in Israel. The first roundtable focused on the gaps between personal income tax and capital’s gains tax, and the way these gaps increase inequality in Israel. The second roundtable revisited the different tax rates imposed on gains from employee’s option plans and the justifications for them. The third roundtable examined ways to employ the tax system to promote innovation, and predominantly the creation of intellectual property in Israel.
The participants in the parallel roundtables included representatives from the Israeli Tax Authority and the Israeli Innovation Authority, as well as lawyers and accountants from the private sector, academic scholars and civil society organisations. Based on the roundtables’ discussions and conclusions, Tax Justice Network Israel in collaboration with FES, has published today three policy papers (in Hebrew), which include specific recommendations for each one of the topics discussed at the roundtables.
The tax rate imposed on capital gains and its link to inequality in Israel
Unlike personal income tax which is taxed through progressive tax brackets up to the marginal tax rate, capital gains in Israel are held by the capital owners and are taxed at a flat and lower tax rate. The paper explains that the current gap between personal income tax rate and capital gains tax is not justified and increases inequity in Israel. In fact, Not only is there doubt as to whether lower tax rates incentivise capital owners to invest their fortune, there is evidence that it damages the incentives of employees and freelancers to integrate in the working market. Furthermore, the gap between the capital gains tax and the personal income tax is a fruitful one for aggressive tax planning which may also exacerbates inequity.
Tax Justice Network Israel concludes there is no justification for imposing on capital gains lower tax rates than those imposed on personal income, except in cases where the Israeli government aims to incentivise a particular sector or resource (eg in cases where, based on informed research results, there is a shortage in real estate or there is a need to encourage pension investments). Furthermore, given that raising the capital gains tax rate to the personal income tax rate is likely to lead to an increase in the tax revenues, there is room to consider whether to use the future revenues from an increased capital gains tax rate to reduce the personal income tax rate.
Reconsideration of taxing employee option plan in Israel
With regard to tax imposed on employees’ option plans, we take the view that there are cases where it is not justified to impose lower tax rates on the gains received from exercising the options or shares. Granting favorable tax rates on the gains from employees’ option plans in Israel has originally been created to alleviate factories in difficulties, but for many years this purpose is largely irrelevant or at least no longer a consideration in providing these option plans. Thus, the paper recommends the government to consider changing the tax rate imposed on the ‘equity track’ embedded in article 102 of the Israeli Tax Ordinance. This is because where the options or shares allotted to an employee are of a trading company, there is no difficulty in assessing the value in any given moment as well as at the end of the vesting period. As such, there is no justification to postpone the tax event to time of realisation of the shares or options. Rather, it should be preceded to the end of the vesting period and the benefits up to this date should be taxed as personal income (rather than as capital income). Nonetheless, to avoid liquidity concerns, is the paper proposes to defer the actual tax payment to the time of realisation of the shares or options, but to add interest and differentials linkage from the end of the vesting period.
Alternatively, if this recommendation is not accepted, the paper suggests that at the very least the government sets an annual limit, by a certain income or percentage of allocation, to the benefits which are taxed at a lower tax rate in the equity track. Accordingly, the employee can enjoy the reduced tax rate only on the annual benefits up to this ceiling and will be required to pay the marginal tax rate on any amount exceeding the ceiling.
Employing the tax system to encourage the creation of intellectual property in Israel
Finally, with regard to employing the tax system to promote the creation of intellectual property, some of Tax Justice Network Israel’s recommendations are the following: extending the options of companies investing in research and development activities to deduct their related expenses; extending the tax benefits provided under the Israeli Law of Encouraging Capital Investment to individuals (rather than only to corporations or partnerships as is currently the case); modifying the eligibility criteria for receiving the benefit and to make sure these benefits are provided for various taxpayers who carry out research and development activities and not only for a limited number of taxpayers; setting a ceiling for the financial benefit that is subject to the reduced tax and monitoring whether companies that have received these benefits are actually initiating significant research and development activities.