Amazingly, the Israeli Tax Authority (ITA) has now clarified how to get round a negative Supreme Court judgement relating to trusts, in a Tax Ruling (3399/22 of August 9, 2022).

The issue:

Israeli real estate gains are taxed and administered completely differently from other capital gains.

The income tax law says that contributing assets (e.g. securities) to a trust for the benefit of Israeli residents may be exempt.

The real estate taxation law says the exact opposite, contributing assets to a trust is taxable for the seller (generally 28%) and the purchaser (up to 10%).

So which is it? The Israeli Supreme Court ruled this year in the Galis Case that in the case of Israeli real estate, the real estate taxation law prevails – pay the tax. But now the ITA has upset the apple cart with its Tax Ruling….

The Supreme Court:

In the Galis case, a Canadian resident couple settled an irrevocable Trust and contributed two Israeli apartments for the benefit of their granddaughter, an Israeli resident beneficiary. The granddaughter did not know about the trust or that she was a beneficiary. The trust documents provided that the Canadian settlors did not control the Trust assets, the Trustee did. The Settlors retained some influence by means of a non-binding Letter of Wishes and the use of a Protector who could make changes regarding the Trustees and Beneficiary(ies).

The Supreme Court ruled that the income tax law exemption expressly did not apply to Israeli real estate (ITO Section 75 Zayin (Vav) and Section 88 definition of “Asset”).

Instead, the Court ruled that the Real Estate Tax Law prevails – this says that a transfer of a right to Israeli real estate to anyone, including a trust or a trustee, is a taxable “sale” (RETL Section 1).

If the Trust later sells the property, another dollop of Israeli tax will be due.

If the trust distributes the property to a beneficiary, exemption from Israeli double taxation is possible according to the Court if timely notifications are filed within 30 days of each act (RETL Secs 69 and 73).

Non-Israeli parties should also check the foreign tax situation. Can Israeli tax be credited at each stage?

The US-Israel tax treaty and other tax treaties do not help much. So maximum care is needed to avoid double or triple taxation. Even quadruple taxation is possible if any of the parties are in business and liable to VAT….

The Tax Ruling:

In this case, a couple owned apartments in Israel used by the family. The couple wished to transfer registration of title to their Israeli lawyer, acting as a trustee holding the apartments for the benefit of the couple.

The Trustee was not authorized to perform any act or transfer of the homes or exercise discretion concerning them, except an act for the benefit of the couple pursuant to express written instruction from them.

Full responsibility for the apartments rests with the couple, and registration of ownership of the apartments in the name of the Trustee doesn’t result in any responsibility for the Trustee. The couple or the Trustee can cancel the trust agreement and transfer back ownership to the couple at any time with 90 days notice.

The Ruling explains that under the real estate tax law:

(1) a trust must have a “specific, concrete, known beneficiary”,

(2) a trust notice must be filed within 30 days after acquisition (of the property) and

(3) “trust relations” must exist per the law and case law.

The Tax Ruling went on to say that a trust need not exist and Israeli taxes may be avoided on the contribution of Israeli real estate to a trust if:

(a) the couple are settlors and beneficiaries;

(b) the couple retain material ownership of the apartments, despite ownership being registered in the name of the trustee,

(c) if the trustee is serving merely as a “nominee/power of attorney holder”,

(d) the Trustee puts into effect what the couple want as beneficiaries, but he has no discretion in this regard.

If the Trustee later sells the real estate, it is the couple who must report and pay tax on that sale, or the heirs must if they sell inherited real estate.  No tax applies to inheritance itself upon death of the settlors (the couple).

What can go wrong? If additions and changes to the beneficiaries are allowed in the trust agreement, transfers in and out the trust are taxable per this ruling.

Comment:

The choice is between considering a trust or a nominee relationship if the ITA’s conditions are met. In practice, the ITA Ruling is problematic if Trustees have discretion, as they often do. Consequently, the ITA announced at the STEP tax conference in Tel-Aviv on September 21, 2022, that they are considering amending and clarifying the Ruling.

Next Step:

If you want to pass on Israel real estate, please consult us and real estate legal advisors about the above among other things, before doing anything. [email protected].

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