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Income Tax in Israel Print
Income tax is a tax levied by the State of Israel on the income of individuals and corporations. The main piece of legislation regulating the imposition of income tax in Israel is the Income Tax Ordinance (New Version), 5721-1961 (hereinafter: the “Income Tax Ordinance” or the “Ordinance”). Under the provisions of the Income Tax Ordinance, the tax is levied in Israel annually on the revenues of residents of Israel produced and accrued in Israel and outside Israel, as well as on the revenues of foreign residents produced and accrued in Israel.

The main distinction used for the imposition of income tax is "ordinary income" as opposed to "capital gain income". It is common to illustrate this distinction using the metaphor of a tree and its fruits: while ordinary income or "yielding income" is the cyclical and ongoing income from the sale of the tree’s fruits, capital gain income is a one-off income resulting from the sale of the tree yielding the fruit. Israeli law makes this distinction in the provisions of the Income Tax Ordinance and, accordingly, the Ordinance contains separate provisions relating to the taxation of ordinary income (in Part B of the Income Tax Ordinance) and to the taxation of capital gain income (in Part E of the Income Tax Ordinance).

The Income Tax Ordinance adopted the “source” doctrine from English law with respect to the taxation of ordinary income. Under this doctrine, as a general rule, in order for a receipt to be liable to tax, it must generate from a source capable of repeatedly producing such receipts. The sources of income set forth in the Income Tax Ordinance (section 2) include, among else, earnings or gains from a business or vocation, income from work (salary), dividend income, interest income and rental income. Section 2(10) of the Income Tax Ordinance also states that also earnings or gains from a source of income not explicitly included in section 2 of the Income Tax Ordinance are taxable. The provisions of section 2 of the Income Tax Ordinance (section 2A of the Ordinance) also include Section 2a of the Ordinance includes provisions concerning the taxation of profits from gambling, lotteries and prizes, whereas section 3 of the Ordinance contains provisions regarding the taxation of “other income”, including income from forgiven debt and “imputed” income (for example, from interest that a controlling shareholder could have made from a loan that he extended to the company he owns).

In order to determine the tax payable by the taxpayer, it is not sufficient to merely calculate his income, but also to calculate the taxable income and to determine the tax rate applicable to the income. For further details regarding the calculation of taxable income and determination of the tax liability, click here.

In addition to the provisions of the Income Tax Ordinance concerning the taxation of ordinary income, Part E of the Ordinance sets out provisions regarding the taxation of gains from the sale of capital assets. Capital gains tax is imposed at the time of sale (including any other disposal) of non-movable assets for personal use, business inventory or real estate assets (which are subject to the provisions of the Land Taxation (Appreciation and Purchase) Law, 5723-1963). Similar to the provisions relating to the taxation of ordinary income, the Income Tax Ordinance prescribes rules for quantifying the taxable capital gains, including its division to real and inflationary components, as well as provisions regarding tax rates applicable to capital gains. For further details regarding the calculation of capital gains tax, click here.