According to the law, prior to the reform, the basis for debiting tax in Israel was mainly territorial.  According to this method of taxation, income tax is imposed on income which was produced or accrued in Israel, whether produced by an Israeli resident or by a foreign resident.  Income tax was imposed on income which was first received in Israel (also if produced or accrued abroad).  The basis of the charge for "first receiving" income in Israel was relevant mainly regarding passive income (dividends, interest, royalties, rent etc.). 

In the framework of the reform, the personal basis was adopted.  According to the law after the reform, Israeli residents are liable to tax on their income whether produced in Israel or abroad, without any connection to the place of receipt of that income.  Foreign residents will be taxed, as in the past, on the income from Israeli sources, according to the rules of source, as detailed below.

Definition of "residency" regarding tax laws

In the taxation method on a total worldwide basis (personal), the matter of defining the tax-payer's residency for tax purposes is of the utmost importance.  As mentioned above, an Israeli resident will be taxed on a worldwide basis, while a foreign resident will be taxed only on income from an Israeli source. 

Test of residency for individuals

According to the law, immediately prior to the amendment of the law, as can be seen from legal verdicts, an individual is considered an Israeli resident if the "center of his life" in the tax year is in Israel.  According to the test of "center of life", most of the individual's connections must be examined and determined whether the center of his life is in Israel.

In the framework of the amendment, the test for ‘the center of life' of an individual is established in the Income Tax Ordinance. For this purpose, it is stipulated that in order to determine whether the center of the life of an individual is in Israel the totality of the tax-payer's family, economic and social connections must be taken into account, including the following considerations:

- The tax-payer's permanent home and the place of residence of his family.

• - The location of his ordinary or permanent place of business or the place of the tax-payer's permanent employment.
• - The place of the tax-payer's active and significant economic interests.
• - The place of the tax-payer's involvement in organizations, societies and various institutions.

In order to determine whether an individual is an Israeli resident or not, a number of presumptions were determined which can be contradicted by the individual or by the assessing officer as follows:

- An individual who stays in Israel during the tax year for 183 days or more, it is presumed that the center of his life in the tax year was in Israel.

• - An individual who stayed during the tax year 30 days or more and the total period of his stay in Israel during the tax year and in the previous two years was 425 days or more, it is presumed that the center of his life in the tax year was in Israel.

The Minister of Finance, with the approval of the Finance Committee of the Knesset, was empowered to determine that certain individuals who are employees of the State or employees of certain institutions (JNF, local authorities, Jewish agency, government corporations and others) will be considered as Israeli residents, even if they are not Israeli residents according to the above test. In addition, the Minister of Finance may determine that certain types of individuals will not be considered Israeli residents.  By virtue of this authority, regulations were issued in which it was determined that an Israeli resident will be seen as an individual who is an employee of the State of Israel, if the employee/employer relations started when he was an Israeli resident, and an employee of the additional bodies stated above (JNF etc.), up to the end of five years from the date on which he started working abroad for that employer.  It was also determined that certain types of individuals will be seen as foreign residents for the period of five years (in certain cases, three) from the date of their arrival in Israel. This list includes, inter alia, diplomatic and consular representatives, soldiers of foreign armies, students, members of the press, foreign sportsmen etc.).

The residency test for corporations

According to the law, immediately prior to the reform, the place of residence of a body of persons was determined according to one of the following alternatives:

- It is registered in Israel and most of his operations are in Israel.

• - Control and management of its business is from Israel.

According to the reform, the definition was amended and it was determined that a body of persons will be considered as Israeli residents if one of the following alternatives exists:

- It is an Israeli corporation (the test of registration and main operations).

• - The control and management of the business is from Israel (this test remains unchanged).

The rules of source for producing income

Apart from a number of exceptions, the previous law did not determine clear rules regarding the place of producing income and relating to the various sources of income ("the source rules"). On the transition to the personal method, there is considerable importance to determining the source rules.  Regarding Israeli residents, the central importance is the need for the question whether a foreign tax imposed on the income of Israeli residents can be credited against the Israeli tax applying to that income because, according to the new law, only foreign tax paid on income from a source which is not in Israel can be credited in Israel (subject to certain exceptions). Regarding foreign residents, the central importance is the matter of determining income to which foreign residents will be liable for Israeli tax, as Israeli tax is imposed on the income of foreign residents only when it is from an Israeli source.  According to the law, after the reform, the source rules in connection with various types of income will be as follows:

It should be stated that the above source rules stipulate a number of exceptions; for example: when a foreign resident has a "permanent enterprise" (e.g.: a branch) in Israel, which makes a payment for which the source is determined according to the residency of the payer (interest, royalties etc.), income by the recipient will be considered as income from an Israeli source (whether an Israeli resident or not), even if the payer is a foreign resident.  When an Israeli resident has a permanent enterprise abroad, the opposite source rules will apply, i.e.: income of the recipient will be considered as income from a foreign source, despite the fact that the payer is an Israeli resident.