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

The status of the Israeli proposal to grant tax exemptions on the sale of digital currencies to foreigners, and to exempt foreigners from Capital Gains taxation on these sales, has been met with significant uncertainty. This comes amid the immediate need for government revenue, arising from the Israeli-Palestinian conflict following the Hamas attack on Israel on October 7, 2003. The goal of the proposal is to establish Israel as a hub for investment in crypto capital and to foster the growth of its crypto sector.

Many foreigners believe this exemption proposal has already become law, while others remain doubtful. This confusion is understandable, since Israel has a similar tax exemption for foreigners who become Israeli residents. Such generous tax exemptions are not available in countries like Canada. Many view Israel as having a generally more favorable tax environment for foreigners.

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

In July of 2023, Israeli lawmakers initiated an early plenary session, where they introduced a proposal to provide tax exemption on the sale of digital currencies to non-residents. The proposal also suggested an exemption on capital gains taxation for the sale of digital currencies by non-residents. 

The main objective of the proposal is to draw foreign crypto capital into Israel and to grow the Israeli crypto sector. It further outlines favorable taxes for transferring digital currencies to employees, including reducing the tax rate on digital currency options from 50% to 25%. Titled "Proposal to Amend the Income Tax Ordinance (Tax Exemption on Sale of Digital Currencies to Non-Residents and Allocation of Digital Currencies to Employees), Hatshep "C" 2023", it is currently under review by the finance committee of the Knesset (Israel's national legislative body), pending preparation for a first reading.

However, amid the Israeli/Palestinian conflict ("iron swords war") and Israel’s immediate need for funds, many question whether Israel is prepared to waive immediate crypto taxation in favor of encouraging future investment through exemptions.

Israel's Current Crypto Tax Policy for Foreign Investors

Israel's proposed exemption of foreigners from crypto tax is unsurprising. Israel already exempts new residents from taxation, offering them a 10-year tax exemption on income from assets or businesses outside the country, including crypto assets. This exemption also applies to interests, dividends, royalties, and capital gains from such assets, starting when the foreigner first becomes an Israeli resident. Similar exemptions are available to returning residents who have lived outside Israel for at least 10 consecutive years.

Aside from these exemptions, Israel’s current taxation system is similar to Canada’s regarding crypto. In Israel, digital currencies are categorized as "assets" rather than currency, as referenced in Article 88 of the Israeli Income Tax Ordinance. The disposition of crypto assets is included as capital gains or business income, depending on the circumstances. If such a disposition, i.e., the sale or exchange of the crypto asset, results in Capital gains, a tax rate of 25% is generally imposed on the gain. However, if the sale results in business income, the tax could reach the top Israeli marginal tax rate of 50%.

Like Canada, Israel taxes non-residents on their Israeli-sourced income and residents on their worldwide income, including earnings from crypto transactions. As crypto assets are not legal tender in Israel, when they are used commercially for purchases, such transactions are treated as barter (exchange of goods or services), and value-added taxes are applicable.

Additionally, residents of Israel with foreign assets worth NIS 1,916,000 or more (approximately $750,000 CAD) must report this to tax authorities per regulation 3(a)(6)(b) of the income tax regulations 1988. This includes crypto assets, with no exceptions for businesses, unlike in Canada.

 Taxation of Crypto Assets in Canada: Foreigner-affiliated Crypto

Canada does not have a similar system to Israel, which exempts new and returning residents from taxes on their assets and businesses outside Canada. Thus, income from digital assets held outside Canada is taxable for Canadian new or returning residents. Upon attaining Canadian residency, a person’s worldwide income post-residency becomes taxable. Non-residents earning Canadian-sourced income are also taxed on that income.

In Canada, crypto assets are generally treated as commodities for tax purposes. If a crypto asset is capital property, 50% of gains from its disposition is subject to capital gains tax. This roughly equals the Israeli tax rate of 25% of the entire gain. However, amendments taking retroactive effect from June 25, 2024, will increase the Canadian capital gains tax inclusion rate to 66.67%, but exempt individuals up to a $250,000 CAD threshold. Certain trust types are also eligible for this threshold exemption. 

Similarly, if Canadian crypto assets are used for business, the income will be taxed as business income, potentially amounting to a combined federal and provincial tax rate of about 50%, akin to the Israeli rate. Furthermore, as crypto assets aren't legal tender in Canada, transactions using crypto as currency are considered barter, same as in Israel. GST/HST will also be applicable.

Finally, Canadian residents holding crypto assets abroad are required to report if foreign property costs exceed $100,000 CAD, although foreign property engaged exclusively in an active business is exempt.

Securities Regulation of Crypto in Israel

From a securities standpoint, Israel lacks a comprehensive regulatory framework for crypto assets. The key legislation is the Israeli Securities Law 1984, with the primary regulatory body being the Israeli Securities Authority.

For securities regulations, Israel evaluates crypto asset attributes to determine if they are similar to securities. Crypto assets may be classified as securities tokens if they offer rights like participatory, ownership, or profit entitlement rights. They are also classified as securities if traded on secondary markets, with regulations governing their offering and sale, especially to the public.

Fund managers, investment advisers, and marketers dealing with Israeli crypto assets must obtain licenses from the Israeli Securities Authority. The licensing consideration includes reviews of the applicant's experience, scheme risk, and money laundering potential. Licensing exams are part of this process. Licensees must maintain records and report to the Israeli Securities Authorities. Also, offering security tokens on foreign exchanges to non-accredited investors is prohibited unless certain conditions are met, per Section 49A of the Securities Law 1968.

Israel also mandates providers of financial asset services, including custody and lending, to get licenses from the Capital Market Authority. According to the Israeli Financial Services Law, cryptocurrency qualifies as a financial asset, referencing Article 11(a)(7) of the Law, necessitating financial services licenses for crypto dealers.

Moreover, the Central Bank of Israel has directed banks to accept cryptocurrency deposits from licensed corporations by the Capital Markets Authority. Non-bank exchange members can also offer cryptocurrency trading and custody services, and the Supreme Court of Israel has ruled that banks may perform digital currency transactions, citing Bits of Gold V Gov of the Bank of Israel 7364/22.

Institutional investors in Israel are required to store their crypto assets with custodians. The Israeli Securities Authority also oversees payment services under the Israeli Payment Services Law 2019, regulating crypto-dealing entities offering payment services.

Israel does not enforce licensing for foreign crypto exchanges, nor do they prohibit Israeli citizens from trading crypto on foreign exchanges. Foreign cryptocurrency trading companies are accessible in Israel, contrasting Canada's approach where unregistered CTP websites are banned and penalties apply.

Importantly, Decentralized Autonomous Organizations ("DAOs") are not recognized as legal entities in Israel, despite their similarity to digital companies.

Canadian Securities Regulation of Crypto

CTPs - Cryptocurrency Trading Companies ("crypto exchanges") offering services to Canadians must be registered, regardless of CTP location. Unregistered CTPs are expected to file undertakings and comply with conditions addressing investor protection until registration is complete. Registration includes risk management, disclosure, and good faith obligations for investor security.

Security law applicability isn't exhaustive and is assessed case-by-case. According to regulations from the Canadian Securities Administrators (CSA) and Canadian Investment Regulatory Organization (CIRO), securities laws apply to crypto assets where they resemble securities or derivatives and are traded on a CTP.

Securities laws will also apply where security tokens are publically traded. CTPs dealing with security tokens and their derivatives must register with CIRO as investment dealers. Moreover, crypto custodian services are regulated, with wallet or similar services storing user crypto subject to securities legislation.

Unlike Israeli banks, Canadian banks do not engage in crypto transactions or accept crypto deposits. However, some Canadian banks and financial institutions offer 'crypto for cash' exchanges and ATM services, managed independently of banks.

As in Israel, DAOs are not Legal Entities in Canada

Israel presents a more crypto-friendly environment for foreigners compared to Canada.

From tax and securities perspectives, Israel appears more welcoming to foreigners and crypto activities.

Israel's 10-year tax exemption for new and returning residents, alongside higher foreign asset reporting thresholds ($750,000 CAD equivalent), offers policies favoring foreign investment and ownership, unlike Canada's absence of similar exemptions and its $100,000 CAD asset reporting limit. Many crypto owners invest in crypto and aren't engaged in foreign crypto businesses, making Israel's broader foreign asset reporting allowance more appealing than Canada's active business exemption.

From a securities perspective, Israel is more open to digital currency compared to Canada. In a global market like crypto, it appears restrictive for Canada to mandate foreign CTPs register domestically before offering services to Canadians.

In contrast, Israel allows foreign CTP access, imposing no restrictions on Israelis utilizing foreign CTPs for crypto exchanges. Israel even permits marketing foreign crypto securities if conditions protecting unsophisticated investors are met, while Israeli banks, by law, accept crypto deposits and transactions, unlike Canadian Banks.

Finally, Israel's consideration of exempting foreigners from crypto tax highlights its openness to digital currencies, although public sentiment may lean towards avoiding tax increases on common assets amidst the Iron Swords War. Thus, secluded asset types like crypto could become targets for increased taxes, hopefully temporarily.

PRO TAX TIPS: Key Factors in Classifying Crypto Transactions as Capital or Business Activity

In Canada, to establish whether crypto asset income is capital or business, the court reviews several aspects, like property nature, disposition frequency, ownership duration, acquisition motive, property improvements, and disposition circumstances.

Income is likely capital if the property is deemed capital, held long-term with minimal effort for marketability, unexpected sale reasons, and the taxpayer’s intent was to earn capital income. The opposite circumstances generally indicate business income.

Israel’s similar considerations include property quality, disposition frequency, holding duration, property ripening, and special disposition circumstances, analogous to Canada's.

Israel also considers disposition volume, organization presence, transaction financing, and field expertise with larger property disposal quantities, permanent disposition setups, loans, and proficiency suggesting business income.

Classification factors in Canada and Israel may interchange or complement each jurisdiction due to their non-exhaustive nature. If you require assistance navigating cross-jurisdictional tax practices, our leading Canadian tax lawyers are here to assist you.

Frequently Asked Questions (FAQs)

What are Crypto Assets?

Crypto assets digitally represent value with transactions validated and secured by cryptographically operated ledgers or similar technology, generally called blockchains. Crypto assets include cryptocurrencies, non-fungible tokens, and security and utility tokens.

What are the classifications and definitions of crypto assets?

Exhaustively accounting for all crypto asset variations is nearly impossible. However, attempts have categorized them into groups, including:

• Cryptocurrencies: These are crypto assets used like currency, i.e., payment means. They include bitcoins, altcoins, dash, Ethereum, and TAO.

Stable coins are value-referenced coins, deriving value from fiat currency, business pursuits, or other crypto assets, explaining their value stability:

• Utility tokens: Crypto assets granting user rights to a service or product.
• Security tokens: Tokens used like securities, including debts, shares, and others, granting ownership, membership, or other security entitlements.
• Non-fungible tokens (NFTs): Digital representations for asset ownership or authenticity, whether virtual or physical. Each token represents a unique asset or right, based on blockchain or similar technology.

Are all Crypto Assets taxed the same way?

In both Israel and Canada, crypto assets are taxed based on their attributes. The method or tax due depends on the crypto asset's characteristics, determining the timing of its taxation.

Disclaimer: This article provides broad information, accurate as of the posting date, but not updated, and potentially outdated. It does not offer legal advice and shouldn't be relied on. Every tax scenario is unique and will differ from those described here. For specific legal queries, it's advised to seek advice from a Chicago tax lawyer.