On January 22, the Israeli Tax Authority (ITA) announced that a 62 year old man suspected of managing a phony trust with a view to evading tax, has just been remanded by the Tel-Aviv Magistrate‘s Court. Apparently, he had claimed tax breaks for trust monies that he enjoyed together with other foreign residents. There followed an investigation and a raid on his home in which many documents were seized.
In the investigation about his fiscal residence, the individual confirmed that although he had lived off and on abroad for a long time, for business reasons, he returned to his home in Israel every weekend. This made Israel his center of living, according to the ITA announcement.
With regard to the trust, the individual apparently claimed he was the beneficiary, although its objective was ‘‘education and food for children around the world‘‘. The trust was formed by a lawyer abroad but the individual contributed assets to the trust, making him a settlor (grantor) according to the Israeli tax law. The trust apparently transferred money to the individual over the years.
The individual‘s accountant apparently stated that ‘‘total support from the trust in 2005 amounted to $1,004,490‘‘. This amount was apparently not reported to the ITA. The individual apparently ‘‘took a chance‘‘ by not reporting the ‘‘dividend‘‘ he received from the trust. They relied on an Opinion given to the individual verbally, according to the ITA announcement.
In addition, the ITA investigation found that the trust was a phony because the individual was considered to be the settlor, and the trustee taking decisions, as well as the beneficiary.
The ITA announcement states that the essence of a trust is an arrangement in which a trustee holds assets for a specific purposes, and acts for that purpose for the benefit of beneficiaries. If the settlor is involved in taking decisions which the trustee ought to take, this is not a trust as defined in the law, and the individual is taxable on income arising, according to the ITA announcement.
It remains to be seen how the court proceedings will go and what the full facts are. In the meantime, here are a number general comments that may or may not be relevant.
First, taking a chance is not the best tax planning technique and is not recommended. Nor is relying on a verbal Opinion.
Second, it is unclear why a 62 year old was a beneficiary of a trust for the benefit of children around the world. Common sense is a key factor in any tax planning.
Third, the Israeli tax law does indeed specify that an Israeli resident individual is someone whose center of living is Israel. The law goes on to specify a number of residency criteria. But visiting Israel every weekend is not one of them. If it was, every Israeli would merely stay in Jordan or Cyprus every weekend in an effort to avoid being an Israeli resident (but that won‘t work, so please don‘t try it).
Fourth, the Israeli tax law has evolved over the years. For example, in 2005 the Israeli tax law didn‘t exactly say that a settlor includes anyone who contributed assets to a trust – that became law in 2006.
Fifth, the trust tax regime introduced in Israel in 2006 is comprehensive. It basically aims to tax the worldwide income and gains of most trusts set up by Israeli residents, regardless of any foreign law, even if the trust is irrevocable and discretionary. In most cases, trust income must be reported by the trustees, even if they are located outside Israel, unless the settlor or beneficiaries agree otherwise.
Nevertheless, exemptions are available for certain trusts with a non-Israeli resident settlor (Foreign Resident Settlor Trust) or non-resident beneficiaries (Foreign Resident Beneficiary Trust) only, if various conditions are met.
So what is a trust?
The use of trusts is said to go back a thousand years to the time when wealthier crusaders put their land into trust while they were away liberating the holy land!
In modern times, there are a number of definitions of the term ‘‘trust‘‘. In Israel, according to the Trust Law, 1979, a trust is a relationship to any property, by virtue of which a trustee is bound to hold the same or to act in respect thereof in the interest of a beneficiary or for some other purpose.
According to the Israeli Income Tax Ordinance, a trust is an arrangement where a trustee holds his assets for a beneficiary, made in Israel or abroad, whether defined by the applicable law as a trust or otherwise.
Just for good measure, there is the Hague Convention on the Law Applicable to Trusts and their Recognition. Israel is not a signatory to this convention, but it is considered by some to be influential. According to this Convention, a ‘‘trust‘‘ refers to the legal relationships created – inter vivos or on death – by a person, the settlor, when assets have been placed under the control of a trustee for the benefit of a beneficiary or for a specified purpose.
How do you know if a trust exists?
According to a leading UK case of Knight v. Knight, dating back to 1840 a trust generally requires three certainties:
(1) Certainty of intention to create a trust,
(2) Certainty of subject matter,
(3) Certainty of objects, i.e. the beneficiaries must be identified or ascertainable.
And according to the Hague Convention, a trust has the following characteristics:
(1) the assets constitute a separate fund and are not a part of the trustee‘s own estate;
(2) title to the trust assets stands in the name of the trustee or in the name of another person on behalf of the trustee;
(3) the trustee has the power and the duty, in respect of which he is accountable, to manage, employ or dispose of the assets in accordance with the terms of the trust and the special duties imposed upon him by law.
The ITA announcement seems to imply that the above trust is a considered a phony, because the trustee should have held the trust assets for someone else, not the same individual.
Therefore, operating a phony trust is like shifting money from your left pocket to your right pocket.
Also, in the case of a ‘‘foreign resident settlor trust‘‘, the Israeli tax law denies a possible Israeli tax exemption if Israeli resident beneficiaries can exercise ‘‘control or influence‘‘ over the conduct of a trust. The ITA has never formally defined ‘‘control or influence‘‘ and not everyone takes this requirement seriously. They should start doing so.
As always, consult experienced tax advisors in each country at an early stage on all relevant aspects in specific cases.
The writer is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.