Dear Clients, Colleagues and Friends,

The Ministry of Finance has recently published a memorandum of law (the “Memorandum”) for the amendment of the Israeli Income Tax Ordinance (the “Ordinance”) aimed at clarifying the taxation of “digital assets”. Digital assets include various types of tokens, such as cryptocurrencies like Bitcoin, which can be used for payment or exchange, and decentralized tokens that represent rights to assets.

The Memorandum clarifies in the explanatory notes that while the use of digital assets carries risks for the economic system, including money laundering, tax evasion, fraud, and more, there are potential opportunities for utilizing this innovative technology. The goal of regulating digital asset activities is to ensure the prudent management of these risks while promoting regulatory certainty for businesses, investors, and consumers involved in digital assets.

The following are the key proposed amendments to the Ordinance in the Memorandum, that are part of a broader regulation of digital assets contemplated by the Israeli Government:

Digital Assets are Property, not Currency

The Memorandum suggests adopting a definition of the term “Foreign Currency” in the Ordinance, which will clarify that only currency issued by a monetary authority of a foreign country would qualify as such. This limitation is intended to prevent ambiguity in cases where digital assets were not issued by a central bank. In such cases, digital assets would not qualify as Foreign Currency under Israeli law (even if they are used as legal currency in another country), and therefore individuals will not benefit from a tax exemption with respect to change in value, nor will non-resident taxpayers be entitled to inflation exemptions with respect to changes in value of the digital assets. This is consistent with a District Court ruling that determined that Bitcoin is not considered a currency for tax purposes.

Taxation of Capital Gains from Digital Assets

The Memorandum proposes to amend the Ordinance in relation to capital gains from the sale or disposition of assets by adding a definition of a “Digital Asset” as a digital representation of value or a right that is transferable and storable electronically, using Decentralized Ledger Technology (DLT) or similar technologies. The Shekel (Israel’s currency) as well as any foreign currency issued by a central bank and securities are excluded from this definition.

The change aims to clarify that Digital Assets are classified as capital assets, which is in line with the Israel Tax Authority’s position as published in a 2018 circular. This essentially means that any sale of a Digital Asset by individuals is subject to a 25% capital gains tax, unless the activity is classified as business income for tax purposes. Corporate entities are also subject to capital gains tax, at a current rate of 23%.

New Source Rules

The Memorandum also proposes to amend the Ordinance to clarify the source rules for capital gains from the sale of Digital Assets. Based on the Memorandum, the following source rules would apply:

1. If the seller of the Digital Asset was an Israeli resident for tax purposes at the time of acquisition of the Digital Asset, the capital gains from the sale would be subject to tax in Israel. This deviates from the regular Israeli exit tax regime which subjects to Israeli tax only the capital gain allocable to the term of Israeli residency. It also raises questions regarding treaty override if the taxpayer selling the Digital Asset qualifies for a tax treaty to which Israel is a party.
2. If the Digital Asset reflects a right, directly or indirectly, to an asset located in Israel, the portion of the capital gains allocable to the asset in Israel would be subject to tax, even if the Digital Asset is located outside Israel.
3. If the Digital Asset represents a right, directly or indirectly, in an Israeli entity, the capital gains from the sale would be subject to tax in Israel.

The Memorandum has yet to be adopted into law. We will keep you posted on developments in this regard. We are at your disposal for planning existing or future transactions involving Digital Assets and are happy to address any questions regarding the legislative process and the Memorandum.

Sincerely,

Herzog Fox & Neeman
The Tax Department