Derivative Players to Be Taxed on Capital Gains, Not Turnover

Investors in derivatives - options or futures - will apparently be taxed on capital gains, not turnover, as the tax reform kicks in next year. The Income Tax Authority had sparked a storm by leaning toward taxation based on turnover as a temporary way to evade the difficulty of calculating capital gains on derivatives.

Turnover tax on investments in other securities - stocks and bonds - will remain in force from January 1, 2003 to January 1, 2004. Tax on actual gains from these securities will only kick in from 2004.

The ITA's decision could substantially moderate the negative implications of the tax reform on the derivatives market. Turnover tax, exacted on transactions whether the speculator makes money or not, is considered a serious deterrent. Some market players worried that it could even kill off Israel's budding derivatives market entirely.

The decision has yet to be finalized, but the banks are likely to make every effort to be ready by January 2003 to calculate capital gains on derivatives and deduct tax accordingly.

While the banks have stated they cannot be ready to calculate and tax capital gains on securities, calculating gains on derivatives is relatively easy because of their short terms. This is also the reason why the ITA has decided to distinguish between derivatives and other investment vehicles.

ITA deputy chairman Oscar Abu-Razak confirmed that the decision stemmed from a desire to prevent undermining the derivatives market. Technically, the banks were capable of collecting tax on derivatives from the start of 2003, he said.

If the banks are not ready to calculate and collect capital gains tax on derivatives when 2003 begins, the ITA may collect a smaller turnover tax than originally envisioned - possibly 2.5 percent of the premium instead of 5 percent. Abu Razak did not confirm this option.