Crypto Taxation to be According to Residency at Time of Purchase

At the start of November 2024, the State Comptroller’s report criticized the Israeli Tax Authority for not effectively collecting taxes on profits generated from crypto activities. It stated that the crypto market is already regulated in many countries worldwide, and is slowly gaining more and more momentum. A week later, the authority issued a draft law addressing the matter.

The draft law concerns the definition of cryptocurrency and the determination of location of income generated during the sale/conversion. Among other things, the amendment proposes that the taxation of Crypto will be determined according to the place of residency at the time of purchase. The proposed amendment will increase clarity in the digital assets market, which is currently worth $3 trillion.

In 2019, the district court issued a ruling in the case of Noam Kopel vs. Tax Assessor of Rehovot. The taxpayer argued that the use of crypto does not constitute as a taxable event, claiming it involves a foreign currency and the taxation of foreign currency is exempt under Section 9(13) of the Income Tax Ordinance. The Tax Authority stated at the time that cryptocurrency is not a currency but rather an “asset.” Due to the fact that cryptocurrency can only be classified as an official currency if it is recognized as a “legal tender” in any country and it is not. In other words, as long as no country has officially adopted a virtual currency (i.e. Bitcoin), as an official currency Crypto cannot be considered a “currency” for tax purposes in Israel. The district court upheld The Tax Authority’s position and ruled that the taxpayer was liable for taxes on the sale of the cryptocurrency.

Since then, the cryptocurrency market has grown, Bitcoin’s value has surged, and some countries (such as El Salvador) has officially adopted Bitcoin as a legal tender. This event arguably defined Bitcoin as a “legal tender,” undermining The Tax Authority’s stance in the Kopel ruling.  

In light of this development, The Israeli Tax Authority issued the draft law. The draft law proposes adding the definition of “digital asset” to the Income Tax Ordinance, which would include all cryptocurrencies, thus addressing the legislative gap regarding crypto.

As part of the regulation, the draft suggests establishing a rule that determines the location where the capital was generated during the sale of cryptocurrency. The determination of the location of the sale is significant as Israeli residents are taxed on their income made worldwide. However, if an Israeli earns income abroad, the provisions of any relevant tax treaty is considered. Additionally, non-residents are only taxed on income or profits made from sources in Israel and are not taxed on income or profits originating from outside of Israel. However, if an Israeli resident earns income from a country which Israel has a tax treaty with, the provisions of the applicable tax treaty must be taken into account. As well, a foreign resident is only subject to taxes on income or profits which originated from Israel and not on those from outside of Israel. The proposed amendment states determining the location of income generated when realizing a digital asset will be based on the residency status of the seller at the time of the purchase. In other words, if the digital asset was acquired when the taxpayer was a foreign resident, the location of the income upon its sale will be considered outside of Israel, and vice versa.

The proposed amendment has advantages, but it has its disadvantages as well.

Advantages and Disadvantages of the Draft Law

Advantages:

1. Certainty – Until now there have been many diverse positions from the Tax Authority regarding the location of income generated from the realization of cryptocurrency (i.e. the taxpayer’s residency status at the time of the cryptocurrency sale, the residence status of the exchange from which the cryptocurrency was sold, etc.). Now, the taxpayer will have certainty regarding the Tax Authority’s position. As many know, when there is legal certainty, it allows for planning and strategizing steps in advance to minimize tax liability.
2. For the first time, the Israeli Tax Authority is establishing a “rule” regarding the location of income derived from a non-tangible asset. It is expected that this rule can also be applied to other intangible assets that are not within the scope of cryptocurrency. (Such as IP, goodwill, and other rights.)

Disadvantages:

1. Discrimination against new immigrants/ returning residents– According to the Income Tax Ordinance, new immigrants, returning residents, and veteran returning residents are entitled to various benefits upon their immigration or return to Israel. Among these benefits is an exemption from tax for a period of ten years on capital gains generated from outside of Israel, regardless of timing or country of residence. For example, if a new immigrant holds securities of a foreign company and later purchases additional securities from another foreign country, then sells all of them during the 10-year exemption period, the capital gains from both sales will be exempt from tax. However, if the new immigrant arrives in Israel with Bitcoin that was purchased while they were a foreign resident, and sells the Bitcoin to purchase Ethereum (another cryptocurrency) during the 10-year exemption period, only the first sale (of the Bitcoin) will be exempt. The second sale (of the Ethereum/ other cryptocurrency) would be subject to tax as it’s considered to be a digital asset purchased after the individual became an Israeli resident. Therefore, even though the sale occurred during the 10-year exemption period, it would not be exempt.
2. Double Taxation– While the Israeli Tax Authority integrates the rule that capital gains will be determined based on the country of residence at the time of purchasing the digital asset, there is no guarantee that foreign tax authorities will adopt this rule as well. Therefore, they may operate according to the tax treaty or their own domestic laws (in the absence of a tax treaty.) This discrepancy can lead to double taxation. For instance, if a taxpayer purchased Bitcoin while being a resident of Israel, then left Israel to move to Germany and sold the Bitcoin several years later, the German Tax Office would require taxes according to their domestic law, as the taxpayer would be a German resident at the time of the sale. (In the case of Germany, taxes would be determined based on the tax treaty between the two countries.) In addition to the taxes paid to the German authorities, the Israeli Tax Authority would also demand taxes, as the Bitcoin was purchased while the individual was a resident of Israel. (A similar situation could arise due to section 100A of the Income Tax Ordinance, which deals with exit tax). There is no reference in the Tax Treaty to cases such as these, leading the taxpayer to possibly paying double tax on the same income.

Possible Tax Planning

As mentioned earlier, when there is law, there is certainty, and when there is certainty one can prepare in advance, plan, and strategically/legally take steps to achieve the minimum possible tax through various tax planning strategies.

As highlighted, this regulation, like any regulation, primary leads to certainty and stability, which brings both advantages and disadvantages. The key is to take advantage of the benefits provided by the regulation, while also being cautious of possible setbacks.

It is important to remember that this is a preliminary draft that may undergo changes before it becomes law. Our firm specializes in Israeli and international taxation, including all matters regarding the digital assets market, as well as the implications arising from this amendment.