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

The status of the Israeli bill aimed at granting tax exemptions on the sale of digital currencies to foreigners and excluding foreigners from Capital Gains taxation on the sale of digital currencies faces considerable uncertainty. This is amid the urgent demand for government funding due to the Israeli-Palestinian conflict following the violent Hamas attack on Israel on October 7, 2003. The bill seeks to establish Israel as a prime destination for crypto investment. It also aims to promote the expansion of Israel's crypto sector.

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

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

In July of 2023, Israeli lawmakers initiated an early plenary session, during which they proposed a bill to grant tax exemption on the sale of digital currencies to non-residents. The bill also suggested an exemption on capital gains taxation for the sale of digital currencies by non-residents. 

The primary goal of the bill is to attract foreign crypto investments into Israel and to widen the Israeli crypto sector. The bill further recommends favorable taxes for transferring digital currencies to employees. This includes lowering the tax rate on digital currency options for employees from 50% to 25%. The bill, titled "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 with the finance committee of the Knesset (Israel's national legislative body), pending preparation for the first reading.

Nonetheless, amid the Israeli/Palestinian conflict ("iron swords war") and Israel's pressing need for funds, many wonder if Israel is ready to forgo urgent crypto taxation in favor of fostering future investments through exemptions.

Israel's Current Crypto Tax Framework for Foreign Investors

Israel's proposed bill to exempt foreigners from crypto tax is not unexpected. This is because Israel already has a policy exempting new residents from taxation. Israel grants such foreigners a 10-year tax exemption on their income from assets or businesses held outside Israel, including crypto assets. The exemption also covers interests, dividends, royalties, and capital gains from such assets. The 10-year period commences when the foreigner first becomes an Israeli resident. Similar exemptions also apply to returning residents who have spent at least 10 consecutive years outside Israel.

Besides these exemptions, Israel currently has a tax regime similar to Canada's regarding crypto. In Israel, digital currencies are perceived as "assets" rather than currency. See Article 88 of the Israeli Income Tax Ordinance. The disposition of crypto assets will be considered either capital gains or business income, depending on the factual circumstances. If such disposition, i.e., the sale or exchange of the crypto asset, leads to Capital gains, a tax rate of 25% is generally applied to the gain. However, if the sale results in business income, the tax could reach Israel's top marginal tax rate of 50%.

Like Canada, Israel taxes non-residents on Israeli sources of income and residents on their worldwide income, including taxes on their incomes from crypto transactions. Because crypto assets are not legal tender in Israel, when a crypto asset is used commercially to purchase goods and services, such transactions are treated as barter transactions (exchange of goods or services), with Value Added Taxes applied.

Lastly, Israeli residents with foreign assets valued at NIS 1,916,000 or more (equivalent to about $750,000 CAD) are required to report this to the tax authorities, according to Regulation 3(a)(6)(b) of the income tax regulations 1988. This includes crypto assets. No exceptions seem to be made regarding the connection of the asset with an active business, as is the case in Canada.

 Taxation of Crypto Assets in Canada: Foreign-affiliated Crypto in Focus

Canada does not have a comparable regime to Israel that exempts new and returning residents from taxes on their assets and businesses held outside Canada. Therefore, income from digital assets held outside Canada is taxable for Canadian new or returning residents. As soon as someone becomes a Canadian resident, their worldwide income earned after becoming a Canadian resident becomes taxable. Non-residents who earn income from Canadian sources will also be subject to tax on that income.

In Canada, crypto assets are generally classified as commodities for Canadian tax purposes. If a crypto asset is held as capital property, 50% of the gains realized from their disposition will be subject to capital gains tax. This roughly aligns with the Israeli tax rate, which is 25% of the entire gain. However, amendments intended to take retroactive effect from June 25, 2024, will increase the Canadian capital gain tax inclusion rate to 66.67%, exempting individuals up to a threshold of $250,000 CAD. Graduated Rate Estates and Qualified Disability Trusts are also eligible for this threshold exemption under certain conditions. 

Additionally, in Canada, if crypto assets are used in a manner that implies a business activity, the realized income will be taxed as business income. This could attract a combined federal and provincial tax rate of about 50%, similar to the Israeli rate. Furthermore, crypto assets are not considered legal tender in Canada. When crypto assets are used as currency to purchase goods or services, such transactions are also treated as barter transactions for tax purposes, as in Israel. Canadian Goods and Services Tax (GST/HST) will also be applicable.

Finally, crypto assets held by Canadian residents outside Canada are considered foreign property. If the costs of the total foreign properties belonging to a Canadian resident exceed $100,000 CAD, they must be reported. However, foreign properties exclusively engaged in an active business are exempt from this requirement.

Securities Regulation of Crypto in Israel

From a securities standpoint, Israel lacks a comprehensive regulatory framework for crypto assets. The primary legislation on the topic is the Israeli Securities Law 1984, and the leading regulatory body is the Israeli Securities Authority.

For securities regulations, the Israeli regime assesses the attributes of crypto assets to determine if they share similarities with securities. Crypto assets are more likely to be classified as security tokens if they enable rights such as participatory, ownership, or profit-entitlement rights. Crypto assets will also be classified as securities if they are to be traded on secondary markets. Securities regulations involve overseeing their offering and sale, particularly to the public.

Fund managers, investment advisers, and marketers in Israeli crypto assets are also required to obtain licenses from the Israeli Securities Authority. Considering granting such a license involves reviewing the applicant's experience level, the risk in the scheme, and potential money laundering. Licensing examinations are also part of the licensing procedure. Licensees have record-keeping and reporting obligations to the Israeli Securities Authorities. Additionally, all individuals are prohibited from offering security tokens traded on foreign exchanges to non-accredited (unsophisticated) investors unless certain conditions are met. See Section 49A of the Securities Law 1968.

Israel also mandates providers of financial asset services, including 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. See Article 11(a)(7) of the Law. Hence, dealers in crypto assets may need to obtain a financial services license.

Moreover, the Bank of Israel has also directed banks to accept cryptocurrency deposits from corporations that have obtained a license from the Capital Markets Authority. Non-bank stock exchange members are also permitted to offer cryptocurrency trading and custody services. The Supreme Court of Israel has even ruled that banks are allowed to conduct digital currency transactions. See Bits of Gold V Gov of the Bank of Israel 7364/22.

Israel requires institutional investors to store their crypto assets with custodians. The Israeli Securities Authority further oversees payment services under the Israeli Payment Services Law 2019. Entities dealing in crypto which provide payment services and facilities are regulated accordingly.

Israel has yet to enforce licensing requirements for foreign Crypto exchanges, and there is no law prohibiting Israeli citizens from trading crypto on foreign exchanges. Foreign cryptocurrency trading companies remain accessible in Israel, unlike in Canada, where the websites of unregistered CTPs are banned, and steep penalties imposed.

Notably, Decentralized Autonomous Organizations ("DAOs") are not recognized as legal entities in Israel, even though they resemble digital companies.

Canadian Securities Regulation of Crypto

CTPs - Cryptocurrency Trading Companies ("crypto exchanges") offering services to Canadians must be registered. It doesn't matter whether the CTP is within or outside Canada. Unregistered CTPs in Canada need to file undertakings and comply with certain conditions addressing investor-protection concerns until full registration is achieved. Registration requirements help to protect investors through risk management, disclosure, and good faith obligations.

Scenarios where security laws will apply are not exhaustive. They are assessed on a case-by-case basis. Based on regulations from the Canadian Securities Administrators (CSA) and Canadian Investment Regulatory Organization (CIRO), security laws will apply to crypto assets if the asset resembles a security or a derivative and is traded on a crypto asset trading platform (CTP).

Security laws will also apply where security tokens are traded publicly. CTPs involved in trading security tokens, their derivatives, and contracts must register with CIRO as members and investment dealers. Moreover, crypto custodian services are also regulated. Where a CTP offers a wallet or similar service for storing user crypto, such provisions fall under securities legislation.

Banks in Canada do not engage in crypto transactions nor accept crypto deposits like their counterparts in Israel. However, some banks and financial institutions offer 'crypto for cash' exchange and ATM services, which are conducted by entities independent of the bank or financial institutions.

As in Israel, DAOs are Not Legal Entities in Canada

Israel offers a more favorable crypto environment for foreigners compared to Canada.

From a tax and securities standpoint, Israel appears to be more welcoming toward foreigners and crypto activities.

The 10-year tax exemption for new and returning residents to Israel, and the greater allowance threshold for reporting foreign assets (equivalent to $750,000 CAD) are current policies that encourage foreign investments and ownership of foreign assets in Israel, as opposed to Canada. This encompasses crypto assets.

The Canadian framework lacks such exemptions for new and returning residents and offers a $100,000 CAD allowance limit for asset reporting. A significant number of crypto owners hold crypto as an investment and are not engaged in foreign crypto businesses. Hence, the Israeli allowance limit for foreign asset reporting will attract more such crypto owners and is more extensive than the Canadian active business exemption.

From a securities standpoint, Israel is more welcoming to digital currency than Canada. In a globally-oriented market like crypto, the Canadian government's requirement for all foreign CTPs to register with Canada before accessing Canadians is quite exclusionary.

This is unlike the Israeli framework, which allows foreign CTPs to remain accessible and imposes no ban on Israeli citizens who reach out to foreign CTPs to trade their crypto assets. The Israeli framework even permits the marketing of foreign crypto securities, as long as the necessary conditions are met to safeguard non-accredited (unsophisticated) investors. Furthermore, Israeli banks accept crypto deposits and engage in crypto transactions as required by law, whereas Canadian Banks do not.

Lastly, Israel's approach in seeking to exempt foreigners from crypto tax reflects the openness of the Israeli government and people to digital currencies. However, the Israeli Iron Swords War appears to be shifting public sentiment towards avoiding tax hikes for the general public. Consequently, secluded asset types, like crypto, are likely to become easy targets for increased taxes. This will hopefully be a temporary situation.

PRO TAX TIPS: What the Court Considers in Determining if a Crypto Transaction is a Capital or Business Activity

In Canada, to decide if income from a crypto asset should be classified as capital or business, the court examines several factors comprehensively, i.e., the nature of the property, the frequency of disposition, the length of ownership, the intention at the time of acquisition, the effort made on the property, and the circumstances surrounding the property's disposition.

The court is more inclined to classify income from a property as capital where: it is a property generally regarded as capital property, the property is held for a long duration, there is minimal or no effort to make the property marketable, unexpected reasons lead to its sale, and the taxpayer's intention when acquiring the property was to earn capital income. The opposite of all the aforementioned circumstances will likely indicate business income.

In Israel, there are similar considerations. These include: the quality of the property, frequency of disposition, duration of holding the property, enhancement and improvement of the property, and special circumstances for disposition. These considerations resemble their Canadian counterparts.

However, Israel has additional considerations, which include: the volume of disposition, the existence of an organization, financing of the property disposition, and expertise in the field.    The larger the quantity of the property disposed of; the existence of a permanent office for its disposition; taking loans to finance the transaction; and proficiency in the field, all point to business income.

All the above classification factors in Israel and Canada are interchangeable and complement each other for both jurisdictions. This is because the factors are not deemed exhaustive by the jurisprudence of both jurisdictions. If you need assistance navigating inter-jurisdictional tax practices, our top Canadian tax lawyers are here to assist you.

Frequently Asked Questions (FAQs)

What are Crypto Assets?

Crypto assets are digital representations of value whose transactions are validated and secured by cryptographically operated ledgers or similar technology, commonly referred to as blockchains. Crypto assets include cryptocurrencies, non-fungible tokens, security, and utility tokens.

What are the classification of crypto assets, and their definitions?

Accounting exhaustively for all the different variations of crypto assets is nearly impossible. However, attempts have been made to group them into categories. Crypto assets are typically classified into the following categories:

• Cryptocurrencies: These are crypto assets used similarly to currency, i.e., as a means of payment. They include bitcoins, altcoins, dash, Ethereum, and TAO.

Stablecoins are value-referenced coins. They may derive their value from fiat currency, business ventures, or even other crypto assets, accounting for the stability in their value:

• Utility tokens: These are crypto assets granting the user the right to use a service or product.
• Security tokens: These are tokens used similarly to securities, such as debts, shares, etc. They provide rights to ownership, membership, or other security entitlements.
• Non-fungible tokens (NFTs): These are digital representations for ownership of an asset or the asset's authenticity or rights in the asset. Such assets could be virtual or physical. Each token represents a unique asset or right in the asset. NFTs are based on blockchain or similar technology.

Are all Crypto Assets taxed in the same way?

Both in Israel and Canada, crypto assets are taxed based on their characteristics. The tax method or due on a crypto asset will depend on the type of attributes the crypto assets exhibit. This will also determine the timing for taxing the crypto asset.

Disclaimer: This article provides general information. It is only current as of the posting date. It has not been updated and may be outdated. It does not provide legal advice and should not be relied on. Every tax scenario is unique to its circumstances and will differ from the instances described in the article. If you have specific legal questions, you should seek the advice of a Dallas tax lawyer.