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ISRAEL: An Introduction to Tax

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Real-Estate Taxation 

The Real-Estate Law (Betterment and Purchase), 1963 (hereinafter: “The law”) governs the field of real-estate taxation in Israel.

The main purpose of the law is to tax real-estate transactions, whether it is a real-estate transaction per se or an indirect possession of real-estate, for example, through shares in a company that directly possesses the real-estate.

The law lays two types of taxes on real-estate transactions which take place in Israel – betterment tax and purchase tax. The betterment tax is laid on the sale of the rights in real estate, and it is a private case of capital gains tax. The sale of other types of assets, apart from real-estate, is taxed according to a different legislation – the Income Tax Ordinance. The purchase tax is laid on the purchase of rights in real-estate, and it is an indirect tax which is laid on the purchase of the rights per se rather than on any gain whatsoever.

The development of the law as of the moment of its legislation and up to its current version is directly related to the trends and the changes that have been implemented in the Israeli real-estate market during the years. Thus, there are numerous examples for cases such as the following: when the tax that is laid according to the law constituted an impediment for the execution of certain real-estate transactions which may set the market in motion and extensively contribute to the wellbeing of the residents and the country, the legislature acted and included various tax benefits in the law in order to remove these impediments and motivate the real-estate market.

One of the main examples therefore is the tax benefits that have been included in the law a number of years ago in order to promote various types of transactions of urban renewal, including urban clearance-construction type transactions.

In a clearance-construction transaction, the entrepreneur purchases a right to build over built-up and populated real-estate. They are usually old and dilapidated neighbourhoods in which the construction is rickety and the infrastructures are of low quality. The residents in these neighbourhoods may not be able to afford a larger or a newer residential apartment. Therefore, the clearance-construction projects are important, as they bring about the improvement of the city centres, the restoration of the failing areas, the effective use of infrastructures and public institutions, etc.

In a clearance-construction transaction, the entrepreneur that makes the transaction with the tenants undertakes to vacate the tenants that reside in the site, to demolish the existing buildings and to build new buildings instead – usually at a higher density and of higher quality – which it will be able to market and to sell. The tenants are compensated with an alternative residential apartment or with another type of unit – such as a store – in the new buildings that will be built in the site itself and/or outside the site. The transaction usually includes an additional consideration for the tenants, such as the payment of their rent for residing in an alternative temporary apartment during the construction process. In addition, the entrepreneur bears all the taxes that apply on the tenants in the transaction, if any.

In practice, a clearance-construction transaction includes two real-estate transactions – one transaction under which the tenants sell the rights in the apartments or in their old units to the entrepreneur, and a second transaction under which the entrepreneur sells new apartments or other types of units to the tenants.

Apparently, it is a highly taxed exchange transaction under which each of the parties is meant to pay betterment tax at the stage of the sale of its property as well as purchase tax at the stage of the purchase of the alternative property. In this type of transactions, the high taxation constituted a significant hindrance in promoting such projects, and therefore, the Israeli legislature interfered and instituted extreme tax benefits for clearance-construction transactions. These benefits include, inter alia, exemption from betterment tax for the tenants during the stage of the sale of their old unit to the entrepreneur and exemption from purchase tax for the tenants during the purchase of the alternative apartment – subject to the terms and the limitations that are instituted in the law.

Based on data that was published by the Israeli Authority for Urban Renewal at the date of writing (the authority which is responsible for the urban renewal field in the Ministry of Construction and Housing of Israel), there are approximately 60 clearance-construction sites where construction has started or that have received a building permit in Israel currently. Furthermore, numerous other projects are also in advanced stages of planning and licensing.

It is therefore fair to say this is a noticeable trend in the Israeli real-estate market which has gained momentum in recent years, inter alia, thanks to the enormous tax benefits that were included in the law and proven to be quite beneficial.

Currently, a review about the real-estate market cannot be written without referring to the impacts of the COVID-19 pandemic. Dealing with the pandemic and its consequences is a prevailing feature of the tax legislation in the real-estate taxation field throughout the last year in an endeavour to grant tax reliefs to the tax payers on the one hand, and, on the other, to enable the real-estate market to further progress and prevent a severe slowdown from which it will be difficult to recover.

One form of relief that was granted by the Israeli legislature as a result of the COVID-19 pandemic is the postponement of various specific dates for taking actions that are instituted in the law. One example for such relief is a provision in the law which grants a lower rate of purchase tax to a resident of Israel who purchases a residential apartment, which is their only apartment in Israel, compared to a person who purchases an apartment for investment. The law even allows a person to purchase an apartment at the low tax rate although they own another old apartment at the same time, as long as the old apartment is sold within a limited time period. Because of the COVID-19 pandemic and the concern about the difficulty of selling the existing apartment in challenging circumstances, the legislature granted reliefs and extended the time period for the sale of the existing apartment for the purpose of receiving the aforementioned tax benefit.

Finally, another significant amendment to the law is the reduction of the rates of the purchase tax while purchasing an apartment for investment, i.e., a residential apartment which is not the only apartment of the purchaser. Prior to the amendment to the law, the rate of the purchase tax of apartments for investment ranged between 8% and 10%. After the amendment to the law, the rate of the purchase tax per apartment for investment was reduced and now starts at a lower tax bracket of 5%.

From the outset the tax rates while purchasing a residential apartment for investment in Israel were increased in order to prevent investors from purchasing residential apartments and thus reducing the prices of the residential apartments in Israel, which had skyrocketed, and turned the opportunity to purchase a residential apartment into a distant dream for many Israeli families.

The increase to purchase tax rate on apartments for investment in Israel led many investors to invest instead in other types of properties or in real-estate properties outside Israel, and on the other hand, it did not help to reduce the prices of the apartments in Israel and even caused an increase in rent fees.

The reduction of the purchase tax for apartments for investment which came into effect a few months ago was designated, inter alia, to attract investors to reinvest in real-estate in Israel. This in turn is intended to encourage construction and growth, especially in these difficult circumstances, which brought about a budgetary deficit which the Government of Israel is attempting to reduce. The data points to the fact that, during the short time that has passed since the reduction of the purchase tax for apartments for investment, the involvement of investors in the purchase of residential apartments in Israel increased.

In conclusion, the year 2020 was a challenging year in many ways but, in spite of the pandemic, the data from the Israeli Ministry of Finance for December 2020 still points to an active and vigorous residential real-estate market.

The Israeli real-estate market is alive and kicking, and there's reason to remain optimistic for 2021, and believe that in spite of the dull forecasts, it will bring about growth and prosperity.