How a Non-Resident Employee Recovered NIS 486,000 Withheld by an Israeli Employer

Result: NIS 486,000 of income tax and NIS 94,000 of National Insurance contributions refunded to a foreign-resident employee · Timeline: 9 months · Challenge: Israeli employer withholding on work performed entirely abroad · Authority: Israel Tax Authority, Tel Aviv assessing office, and the National Insurance Institute · Financial Impact: NIS 580,000 recovered, NIS 12,900 a month retained going forward

Background

A senior backend engineer left Israel with his wife and two children in August 2022 and settled in Lisbon. He kept his job. His employer, a forty-person Tel Aviv software company, had no entity abroad and no appetite for building one, so the simplest thing for the payroll bureau was to leave him exactly where he was: on the Israeli payroll, on an Israeli payslip, with full income tax deducted at source and National Insurance and health contributions taken alongside it.

By the time he came to us in late 2025 he had been paying tax twice for more than three years. He was assessed as a resident where he lived and taxed there on the same salary, and his accountant abroad had told him the credit he was claiming for the Israeli deductions was exposed, because the tax was not one Israel had a right to charge. His gross salary was NIS 46,000 a month. Roughly NIS 148,000 a year was going to the Israel Tax Authority and another NIS 30,000 a year to the National Insurance Institute, from a man who had not worked a day in Israel since 2022 and whose children were in school in Portugal.

He had raised it with his employer twice. Both times the payroll bureau said it could not stop deducting without written authority, which was correct, and nobody had gone to get the authority.

The Challenge

The employer was not being difficult. Section 164 of the Income Tax Ordinance 1961 puts a positive duty on a payer of employment income to deduct tax at source, and a payroll bureau that stops deducting on a verbal assurance from an employee carries the liability itself. The authority to pay gross has to come from the assessing officer, in writing, and somebody has to ask for it.

Underneath that sat the substantive question. A foreign resident is taxed in Israel only on Israeli-source income, and the source rule for employment income is in Section 4A(a)(4) of the Income Tax Ordinance 1961: the place where the income is produced is the place where the work is performed. His work was performed at a desk in Lisbon. The identity of the employer, the currency of the payslip, and the location of the bank account receiving the salary are all irrelevant to that test.

There is one exception and it is narrow. Section 4A(b)(1) pulls work performed abroad back into the Israeli net where the employer is the State of Israel, an Israeli local authority, the Jewish Agency, or Keren Hayesod, and even then only where the employment relationship began while the employee was an Israeli resident. A private software company is not on that list. This is the point where most of these cases are won or lost, because clients and payroll bureaus both assume that an Israeli employer means Israeli tax, and the statute simply does not say that.

That left residency itself, which was the only genuinely contestable element. Under Section 1 of the Income Tax Ordinance an individual is an Israeli resident if his centre of life is in Israel, supported by two rebuttable presumptions: 183 days in the tax year, or 30 days in the year together with 425 days across that year and the two preceding it. He flew back for two-week planning sprints four or five times a year, which came to around 63 days annually and 189 days across three years. Both presumptions pointed away from Israel, and his family, home, schools, doctors, and social life were all in one place abroad. The draft bill published for public comment on 2 July 2025 would add conclusive day-count bands to the definitions, but in August 2026 it remains a memorandum with no enacted text, so the centre-of-life test still governs.

In Practice: Under Section 4A(a)(4) of the Income Tax Ordinance 1961 employment income is sourced where the work is performed, and the Section 4A(b)(1) exception covers only the State of Israel, an Israeli local authority, the Jewish Agency, and Keren Hayesod. On a NIS 552,000 annual salary, that distinction was worth about NIS 148,000 a year in Israeli tax, recoverable for six years under Section 160 with linkage and 4% annual interest through the Tel Aviv assessing office.

What We Did

The work ran on two tracks, because stopping the bleeding and recovering the past are different procedures with different counterparties.

Establishing the residency position. We filed annual returns on Form 1301 for the 2023, 2024, and 2025 tax years, each with Form 1348 attached. Form 1348 is the residency declaration that accompanies the return, and it is where the case is actually made. We set the severance date at 1 September 2022 and evidenced it rather than asserted it: the Portuguese lease and later purchase deed, the children's school registrations, the local tax registration and assessments, the health insurance enrolment, the closure of the Israeli rental, the utility accounts, and the full entry and exit report from the Population and Immigration Authority showing every border crossing since 2019. We claimed refunds only from the 2023 tax year. The 2022 year was mixed, the sums were modest, and arguing a part-year apportionment would have slowed the whole file down for very little.

Stopping the withholding. In parallel we applied to the assessing officer for a written instruction to the employer permitting payment of the salary without deduction of Israeli tax at source. That instruction arrived before the refund did, which is normal and is the more valuable of the two for a client living on a monthly salary. The payroll bureau implemented it from the following month.

The National Insurance side. Insurance under the National Insurance Law [Consolidated Version] 5755-1995 follows residency, not citizenship and not the payroll on which someone happens to sit. We filed a residency questionnaire with the National Insurance Institute and obtained a determination fixing the end of his residency, which produced a refund of the employee contributions deducted since that date. We were explicit with him about the cost of that determination: his health cover under the National Health Insurance Law 1994 ended on the same date, and if the family ever returns, Section 58 of that Law imposes a waiting period of one month for each year of absence up to a maximum of six months, or payment of the redemption fee, which stands at NIS 16,860 in 2026.

The exit charge. Ceasing Israeli residency is a deemed sale of assets under Section 100A of the Income Tax Ordinance 1961. He held a portfolio of Israeli-traded securities worth roughly NIS 700,000 on the departure date. He did not elect to pay at departure, so the charge defers to the actual disposal, at which point only the portion of the gain attributable to the Israeli holding period falls into the Israeli net. His employee options sat with a Section 102 trustee and were dealt with separately on their own timetable.

In Practice: Section 160 of the Income Tax Ordinance 1961 allows a refund of tax paid in excess for up to six years from the end of the relevant tax year, with CPI linkage and 4% annual interest, and that interest is itself exempt from tax. On three tax years of over-withheld salary the Tel Aviv assessing office refunded NIS 444,000 of principal plus NIS 42,000 of linkage and interest, roughly five months after the returns were filed.

We also raised something the client had not asked about. An employer with a full-time employee working from another country can create a taxable presence for itself there, and the exposure sits with the company rather than the employee. We flagged it in writing to both of them and recommended the company take local advice on converting the arrangement to a contractor relationship or an employer-of-record. That is the company's decision, not ours, but a client who costs his employer an unexpected assessment abroad does not stay employed for long.

The Outcome

The Israel Tax Authority refunded NIS 486,000, made up of NIS 444,000 of over-withheld income tax across three tax years and NIS 42,000 of linkage and interest under Section 160. The National Insurance Institute refunded NIS 94,000 of employee contributions from the residency severance date. Nine months elapsed from our first meeting to the last payment landing, of which about five were the assessing office working through the file.

Going forward the change is larger than the refund. His salary is now paid without Israeli deduction, which left roughly NIS 12,900 a month in his hands that had previously gone to Israel and been claimed back, imperfectly, as a credit abroad. Over a normal working decade that is the more significant number by a wide margin.

Two things made this file straightforward that would not have been true for everyone. He had kept documents, and he had genuinely severed. Had he retained an Israeli apartment for his own use, kept his children in an Israeli school year, or spent five months a year in Tel Aviv, the same claim would have been a contested residency assessment rather than a refund application, and it would have taken two years rather than nine months. If you are anywhere near that line, our guide to the 183-day rule and Israeli tax residency explains where the presumptions bite.

Key Takeaways

What this case illustrates for non-residents in similar situations:

1. An Israeli employer does not make your salary Israeli income. Section 4A(a)(4) of the Income Tax Ordinance 1961 sources employment income to the place where the work is performed, and the Section 4A(b)(1) exception is limited to four public bodies. A private company anywhere in Israel is not one of them.
2. The payroll bureau cannot fix this and should not be asked to. Section 164 imposes the withholding duty on the payer, so the only thing that stops the deduction is a written instruction from the assessing officer. Somebody has to apply for it, and the employee is usually the one with the incentive.
3. Six years is the outer limit, and it runs from the end of each tax year. Section 160 allows recovery with linkage and 4% annual interest, but a year that closes is closed. Every twelve months of delay costs a full year of the oldest claim.
4. Form 1348 is evidence, not a declaration. Leases, school registrations, local tax assessments, health enrolment, and the entry and exit report from the Population and Immigration Authority are what carry a residency severance. A statement that your centre of life moved carries nothing on its own.
5. Count the cost of severing before you claim it. Ending residency ends National Insurance and health cover from the same date, and a return brings a waiting period of up to six months under Section 58 of the National Health Insurance Law 1994 or a redemption payment of NIS 16,860 at 2026 rates.

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Facing a Similar Situation?

If you left Israel but stayed on an Israeli payslip, or you are being taxed in two countries on one salary, the position can usually be established from documents you already hold, and the refund window closes one tax year at a time.

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