The Israeli regulators and financial system approach towards cryptocurrencies has been a matter of criticism in the past several years due to lack of clarity and regulatory guidelines. However, the Israel Tax Authority (the “ITA”) has been taking operational steps and has initiated processes in order to create a clear path towards taxation regulation regarding cryptocurrencies and to enable taxpayers to execute their tax duties. These steps had grown since the increased inflation environment and interest rates, as well as heightened debt resulting from the ongoing war.

 

Classifying digital currencies

 

According to the ITA, digital currency is considered an “asset” for Israel tax purposes and, therefore, any sale of digital currencies triggers a tax event for the seller. In most cases, income generated from the sale of a digital currency would be classified as capital income and, correspondingly, subject to capital gains tax; however, income generated from an activity involving digital currencies could also be classified as “business” (ordinary) income based on the criteria and tests adopted in tax law for doing so and will likewise be taxed according to the prevailing income/corporate tax rates. In terms of VAT, income generated from the sale of digital currencies by an investor whose activity does not include business characteristics will not be subject to VAT; however, investors whose activities in digital currencies do bear business characteristics will be classified and registered as a “financial institution” for VAT purposes and will thus be taxed accordingly.

 

Following-up on the publication of its general interpretative viewpoint on the taxation of digital currencies, the ITA subsequently published its position on several additional subtopics related to the field of digital currencies including, for example, the sale of NFTs, public offerings of digital tokens, the manner of recording receipts (received in the form of digital currencies) in consideration for services, etc.

 

Circumventing the difficulty in depositing proceeds in Israeli banks

 

Publication of the ITA’s position regarding the taxation of activities entailing digital currencies did not resolve the various practical difficulties faced by holders of digital currencies in so far as relating to their holding of such currencies and depositing the profits generated from them into their local bank accounts.  (Such difficulties emanate largely from the banking system, which in turn has found it a challenge to manage and oversee the inherent risks in handling and dealing with digital currencies.) In view of current banking regulations and practice, the commercial banking system in Israel generally makes it difficult in most cases to receive funds originating from digital currencies due largely to the complexity in tracking the source of those funds and the concern of their likely association with money laundering or terrorist financing. The inability to deposit the proceeds generated from the sale of digital currencies in the seller’s Israeli bank account, makes it likewise an obstacle for the seller to pay the relevant tax liability to the ITA, largely because all tax payments need to be made from an Israeli bank account. This latter impediment led to the submission of several lawsuits seeking the Israeli courts’ intervention and say in the matter.

 

As a consequence, last year, the ITA finally published a guideline titled “Temporary Order Procedure for Receiving the Payment of Tax for Profits Generated from the Sale of Digital Currencies” (the “Procedure”). The Procedure was initially stated to have application for a period of 6 months only, beginning from January 1, 2024. However, on July 1, 2024, the ITA published a notice extending the validity of the Procedure for a further 6 months, until December 31, 2024.

 

Principally, the aim of the Procedure is to allow Israeli taxpayers who have generated profits from digital currencies to duly report and pay the associated taxes as required. In terms of the Procedure, the tax liability will be deposited into a bank account of the ITA that will be managed by the Bank of Israel, thereby circumventing the difficulties inherent in the Israeli banking system. To this end, it will be necessary to prove to the ITA that the commercial banking system in Israel (i.e., at least one Israeli bank) refused to accept the funds, including its refusal to open a local bank account for doing so.

 

Essentially, the taxpayer should submit a request to the ITA for onward handling by the various divisions within the ITA (the relevant income tax assessor, the professional division, the investigations and intelligence division, as well as the enforcement and collection division). To initiate the Procedure, the taxpayer is required to submit a request to the relevant assessor and report his activity in digital currencies, the taxable income and tax due, following which the assessor will determine the relevant tax liability, derived from the digital currencies as part of the assessment agreement, based on the data included in the taxpayer’s report. In addition, the seller is required to furnish various details, waive confidentiality, give various statements and provide sundry references, as detailed below.

 

In April 2024, the ITA published a guideline detailing the process and stages for handling requests of such nature by the various divisions within the ITA. Thus, for example, the taxpayer is required to submit a request to pay the applicable tax on a designated form (Form 909), which will need to be submitted separately for each tax year. The taxpayer will need to detail his activity in digital currencies, including the purchase price paid for the digital currencies and the sale price, his taxable income and the tax due based on a written calculation that will be attached to the form. Moreover, the taxpayer will need to provide additional data, including, among other things, the tracked currency movements throughout the holding period and details of the accounts/entities located abroad from which the funds are to be transferred. The form will also include the taxpayer’s agreement to waive confidentiality such that the ITA will be able to transfer all information in its possession to the knowledge of the Money Laundering and Terror Financing Prohibition Authority and the police, an undertaking to pay the amount of tax due to the ITA, regardless of approval of the taxpayer’s request to transfer the tax payable from a foreign bank account to the ITA’s bank account, irrevocable consent that the amount of tax paid will not be refunded to the taxpayer even if losses, deductions or credits, as applicable, were occasioned in the tax year that were not reflected in the assessment agreement or self-assessment, a statement that the funds used to purchase the digital currencies were legally sourced, as well as a statement that the taxpayer and/or his/her spouse is/are the sole owner(s) of the digital currencies referred to in the request. The guideline also determines the way in which the assessor will make the necessary evaluations and perform the required tests. If the assessor rejects the taxpayer’s request, he must notify the taxpayer of this in writing, and give reasons for the rejection.

 

Lastly, it should be emphasized that the Procedure does not absolve taxpayers of the need to disclose income earned by them by way of the voluntary disclosure procedure in the appropriate circumstances. In this context, we understand that the ITA will soon publish a specific voluntary disclosure guideline that will also address the matter of unreported income generated from digital currencies.

Published at Lexology

Ophir Kaplan, Partner, Tax Practice

Gal Arad Cohen, Partner, Blockchain and Digital Assets