Uncertainty over Israel's Proposal to Exempt Foreigners from Crypto Tax

The status of the Israeli proposal to offer tax exemptions on digital currency sales to foreigners and to exempt foreigners from Capital Gains taxation on such sales has encountered notable uncertainty. This coincides with the immediate government revenue demands, ensuing from the Israeli-Palestinian conflict due to the Hamas attack on Israel on October 7, 2003. The bill intends to make Israel a prime destination for crypto capital investment and aims to bolster the Israeli crypto industry.

While many foreigners believe the tax exemption bill is now law, others remain skeptical. Such confusion is expected, given Israel's past provision of similar tax exemptions for foreigners becoming Israeli residents. Countries like Canada do not offer such generous exemptions. Many view Israel as generally having a more attractive tax landscape for foreigners.

Has Israel Enacted a New Law to Exempt Foreigners from Crypto Tax?

On July 2023, Israeli legislators opted for an early plenary session during which they presented a proposal for tax exemption on digital currency sales by non-residents. The proposal also suggested a capital gains tax exemption for digital currency transactions by non-residents. 

The chief purpose of the proposal is to draw foreign crypto capital to Israel and to grow the Israeli crypto sector. The proposal also presents favorable conditions for transferring digital currencies to employees, such as reducing the tax rate on digital currency options for employees from 50% to 25%. This proposal, termed "Bill to amend the Income Tax Ordinance (tax exemption in the sale of digital currencies to non-residents and in the allocation of digital currencies to employees), Hatshep "C" 2023" is currently under review by the finance committee of the Knesset (Israel's parliament), and is awaiting preparation for its first reading.

Yet, amid the Israeli/Palestinian conflict ("iron swords war") and Israel's urgent need for financial resources, speculation arises regarding Israel's readiness to forego urgent crypto taxation in favor of fostering future investment through exemptions.

Israel's Existing Crypto Tax Framework for Foreign Investors

The proposed Israeli bill to exempt foreigners from crypto tax is not unexpected, as Israel already exempts new residents from taxation. New Israeli residents enjoy a 10-year tax exemption on income from assets or businesses held outside Israel, pertinent to crypto assets as well. This exemption covers interest, dividends, royalties, and capital gains from such holdings. The 10-year period starts when the foreigner first becomes a resident of Israel. Similar conditions apply to returning residents who have lived abroad for at least 10 consecutive years.

Besides these exemptions, Israel's tax regime on crypto is comparable to Canada's. In Israel, digital currencies are classed as "assets" rather than currency. See Article 88 of the Israeli Income Tax Ordinance. The disposition of crypto assets will count as either capital gains or business income, based on factual circumstances. If the disposition, such as selling or exchanging the crypto asset, results in capital gains, a 25% tax rate generally applies. However, if it constitutes business income, taxes may reach the top marginal rate of 50% in Israel.

Like Canada, Israel taxes non-residents on income sourced from Israel and residents on global income. This policy includes taxes on income from crypto transactions. Since crypto assets are not legal tender in Israel, using them commercially for purchases or services classifies as a barter transaction (a goods or services exchange), subject to Value Added Taxes.

Residents of Israel with foreign assets valued at NIS 1,916,000 or higher (approximately $750,000 CAD) must report them to tax authorities per regulation 3(a)(6)(b) of the income tax regulations 1988. Crypto assets are included in this requirement without exceptions tied to an active business, differing from the Canadian standard.

 Taxation of Crypto Assets in Canada: Foreign Associated Crypto Consideration

Canada does not offer a regime similar to Israel's, exempting new and returning residents from taxes on assets and businesses outside the country. Thus, income from digital assets outside Canada is taxable for new or returning Canadian residents. Upon establishing Canadian residency, one’s worldwide income earned thereafter becomes taxable. Non-residents with Canadian-sourced income face tax obligations on these earnings.

In Canada, crypto assets are typically classified as commodities for Canadian taxation. If a crypto asset is held as capital property, 50% of gains from its disposition are subject to capital gains tax. This is somewhat analogous with the Israeli tax rate, which is 25% of total gain. Yet, amendments to take effect retrospectively from June 25, 2024, will increase the Canadian capital gain tax inclusion to 66.67%, with exemptions for individuals up to $250,000 CAD. Graduated Rate Estates and Qualified Disability Trusts may qualify for this exemption under certain conditions. 

In Canada, if crypto assets denote business activities, the resulting income incurs business income tax. This may produce a combined federal and provincial rate near 50%, parallel to Israel’s. Furthermore, crypto assets do not constitute legal tender in Canada. When employed as currency for goods or service purchases, these actions for tax purposes are classified as barter transactions, akin to Israel’s tax treatment. Canadian Goods and Services Tax (GST/HST) also applies.

Crypto assets owned by Canadian residents outside the country are deemed foreign property. When all foreign property belonging to a Canadian resident surpasses $100,000 CAD in cost, a report is mandatory. Yet, foreign property solely for active business is exempt from this requirement.

Regulating Crypto Securities in Israel

From a securities standpoint, Israel lacks an all-encompassing regulatory framework for crypto assets. The main legislative reference is the Israeli Securities Law 1984, with oversight by the Israeli Securities Authority.

For securities regulation, Israel examines characteristics of crypto assets to assess their alignment with securities. Crypto assets may fall into securities token classification when they provide participatory, ownership, or profit rights. Likewise, designation as securities is likely if they trade on secondary markets. Regulations cover security offers and sales, particularly to the public.

Managers, advisers, and marketers dealing with Israeli crypto assets must secure licenses from the Israeli Securities Authority. The prospect of awarding such licenses involves a review of the applicant’s experience, risks, and anti-money laundering measures. Licensing examinations are part of the licensing process. Licensees must maintain records and report to the Israeli Securities Authority. Moreover, offering security tokens on foreign exchanges to unsophisticated investors is typically prohibited without meeting certain criteria outlined in Section 49A of the Securities Law 1968.

Israel requires service providers handling financial assets, which includes custody and lending services, to obtain a license from the Capital Market Authority. Under the Israeli Financial Services Law, virtual currency (i.e., cryptocurrency) qualifies as a financial asset, per Article 11(a)(7) of the Law. Thus, crypto asset dealers may need a financial services license.

The Central Bank of Israel mandates banks to accept cryptocurrency deposits from corporations with a Capital Markets Authority license. Non-bank stock exchange members can offer cryptocurrency trading and custody services. The Supreme Court of Israel affirmed banks' ability to conduct digital currency transactions, per Bits of Gold V Gov of the Bank of Israel 7364/22.

Institutional investors in Israel must store crypto assets with custodians. Additionally, the Israeli Securities Authority regulates payment services under the Israeli Payment Services Law 2019, resulting in the regulation of crypto-dealing payment service providers.

Israel no longer requires licensing for foreign crypto exchanges, nor does it ban Israeli citizens from utilizing foreign exchanges. Foreign crypto trading operations remain reachable within Israel, unlike Canada's regulations where unregistered CTP websites are prohibited and stringent penalties are enforced.

Notably, Decentralized Autonomous Organizations ("DAOs") are not legally recognized entities in Israel, although they share similarities with digital companies.

Canadian Regulation of Crypto Securities

CTPs - Cryptocurrency Trading Platforms ("crypto exchanges") serving Canadians must be registered, irrespective of location. In Canada, unregistered CTPs must file undertakings and comply with specific investor-protection conditions until fully registered. Registration is intended to safeguard investors, ensuring risk management, disclosure, and good faith.

Security law applicability is variable, assessed case-by-case. According to policies from the Canadian Securities Administrators (CSA) and Canadian Investment Regulatory Organization (CIRO), securities laws apply when crypto assets function as securities or derivatives on trading platforms (CTP).

Security laws also govern situations where security tokens are publicly traded. CTPs engaged with security tokens, their derivatives, and contracts must register with CIRO as members and investment dealers. Moreover, custody services in crypto fall under scrutiny. A CTP providing wallets or similar services, where user crypto is stored, is subject to securities legislation.

Canadian banks do not facilitate crypto transactions nor accept crypto deposits, unlike Israeli banks. However, several banks offer 'crypto for cash' exchange and ATM services, conducted by independent entities.

DAOs are Not Legal Entities in Canada Just as in Israel

Comparatively, Israel offers a more favorable environment for foreign crypto activity than Canada.

From the tax and securities standpoint, Israel appears more welcoming to foreign investors and crypto enthusiasts.

Ready policies, like the 10-year tax exemption for new and repatriating residents in Israel and the increased foreign asset reporting threshold (approximately $750,000 CAD), significantly favor foreign investments and holdings in Israel, including crypto assets, over Canada.

Canada lacks equivalent exemptions for new and repatriating residents, offering instead a $100,000 CAD reporting threshold. Most crypto holders retain crypto as an investment, lacking foreign business involvement. Thus, Israel's allowance threshold is more appealing and comprehensive than Canada's active business exemption.

Regarding securities, Israel’s policies allow greater flexibility for digital currency use than Canada. In a global crypto market, Canada's restrictive registration requirement for foreign CTPs limits access to Canadians.

Israel's approach differs by allowing foreign CTPs accessibility without restrictions on Israeli citizens transacting on these platforms. Additionally, the Israeli system allows marketing of foreign crypto securities, given investor protection measures are satisfied. Israeli banks are even compelled to accept crypto deposits and engage in crypto transactions by law, a stark contrast to Canadian banks.

Ultimately, Israel’s inclination towards exempting foreigners from crypto tax demonstrates the Israeli government's and populous's acceptance of digital currencies. Nonetheless, arising public sentiment due to the Israeli Iron Swords War might push for tax avoidance among the general populace. Consequently, niche asset types, like crypto, are likely to become potential targets for increased taxation. This scenario is hopefully short-lived.

PRO TAX TIPS: Factors Courts Consider in Assessing a Crypto Transaction as Capital or Business

In Canada, determining whether crypto asset income should be treated as capital or business involves several holistic factors, including property nature, disposition frequency, ownership duration, acquisition motive, effort on property, and property sale circumstances.

Court categorization of income as capital is more likely when: the property is typical of capital property, held long-term, minimal or no marketing effort exists, unexpected sale reasons prevail, and the taxpayer acquired it intending to earn capital income. Conversely, opposite conditions may suggest business income.

In Israel, similar considerations apply, including property quality, disposition frequency, holding duration, property enhancement, and special disposition circumstance, aligning with Canada's approach.

However, Israel factors in disposition volume, organizational presence, property disposition financing, and field expertise. A larger disposed quantity, a permanent office for its disposal, loans taken for the transaction, and proficiency in the field, all suggest business income.

The classification considerations in Israel and Canada are interchangeable and supportive across both jurisdictions. This stems from the non-exhaustive jurisprudence of both regions. If you need guidance on cross-border tax practices, our top Canadian tax lawyers can assist you.

FAQs: Frequently Asked Questions

What are Crypto Assets?

Crypto assets are digital value representations secured and validated through cryptographic ledgers or similar technology, commonly referred to as blockchains. They encompass cryptocurrencies, non-fungible tokens, and security and utility tokens.

What Are the Classifications of Crypto Assets and Their Definitions?

While covering all crypto asset variations is challenging, they typically fall into categories. Crypto assets usually classify into:

• Cryptocurrencies: assets used akin to currency as a payment means, including bitcoin, altcoins, dash, Ethereum, and TAO.

Stable coins are coins pegged to value references like fiat currency, business pursuits, or other crypto assets, reflecting their value stability:

• Utility tokens: assets granting user rights to a service or product.
• Security tokens: tokens resembling securities like debts or shares, granting ownership, membership, or other security rights.
• Non-fungible tokens (NFTs): digital ownership representations for an asset or its authenticity. Assets may be virtual or physical, with tokens representing unique asset rights. NFTs leverage blockchain or similar technology.

Are Crypto Assets Uniformly Taxed?

In both Israel and Canada, crypto assets are taxed according to their attributes. The tax type or due on a crypto asset depends on how its attributes manifest. This also informs the taxation timing for the crypto asset.

Disclaimer: This article offers general information, current as of posting date. It has not been updated, hence may be outdated. It does not render legal advice and should not be used as such. Each tax scenario is unique and may diverge from the instances discussed herein. For specific legal inquiries, seek counsel from a tax lawyer in Miami.