Can 80% tax on inheritances be avoided? Can zero Israeli tax be achieved without a ruling?
Readers of this column reacted in very large numbers to an article about inheritances from abroad in The Jerusalem Post on January 11, 2006. So potential heirs in Israel and their donors/bequeathers living elsewhere will be interested to know there has been an important development.
What‘s the problem?
As a matter of public policy (‘‘soak the rich‘‘), many countries impose an estate tax or inheritance tax upon death, as well as tax on lifetime gifts, subject to various rules and exemptions. These taxes can bite into the family wealth in a big way.
For example: 40 percent in the United Kingdom; about 24% in Canada (capital-gains tax), depending on the province; 20% in South Africa; and up to 60% in France, apparently. In the United States, there is no federal estate tax in 2010, but it is scheduled to return with a vengeance at rates ranging up to 55% in 2011, not to mention state estate taxes.
What about Israel?
It is wrong to say that Israel does not tax inheritances. It is true that Israel abolished its estate tax in 1981. However, Israel imposes capital-gains tax on Israeli residents who sell inherited assets anywhere in the world, applying the cost basis of the last person that paid full consideration for those assets.
For example, Isaac lives in Israel and now inherits a house in London from his late father, Abraham, that cost GBP 100,000 in the 1960s and is now worth GBP 1 million. Let‘s suppose the UK estate nil-rate band (the exempt amount) has been used on other gifts and bequests; in such a case, the UK inheritance tax may amount to GBP 400,000 (40%).
Isaac then decides to sell the house and cash in his GBP 1m. He will have 30 days to report and pay Israeli capital-gains tax on the capital gain of GBP 900,000 – at rates ranging from 20% to 45%. The 20% rate applies to the post-2002 portion of the inflation-adjusted gain (see below) on a time-split basis. But rates ranging up to 45% currently apply to the pre-2003 portion of the gain.
In other words, a combined tax burden of more than 80% tax is easily possible in the two countries. This problem applies to assets situated in any country with an estate/inheritance tax, not only the UK, regardless of where the donor/deceased resided. There is no provision in Israeli law or most tax treaties that expressly grants a credit for foreign estate/inheritance taxes against Israeli capital-gains tax. This is like mixing apples and oranges.
To add insult to injury, the capital gain will be calculated for Israeli tax purposes in new Israeli shekels and adjusted for inflation according to the Israeli consumer-price index. Only the post-1993 inflationary gain is exempt: i.e., an additional 10% tax will be imposed on the pre-1994 inflationary gain!
Can 80% tax on inheritances be avoided?
First, always do lifetime tax planning in each country in good time. Most countries offer limited reliefs from their tax on gifts and inheritances. But these are often insufficient. Fortunately, the Israel Tax Authority has just come to the rescue.
On January 13, 2010, the Tax Authority announced a fast-track procedure (‘‘Green Channel‘‘) for issuing tax rulings that allows taxpayers who receive an overseas asset by way of a gift or inheritance to ‘‘step up‘‘ the asset cost for Israeli capital-gains tax purposes to its fair-market value when the donor died or made the gift. This step-up is a concession available regardless of whether tax is paid abroad or who the transferor is.
In addition, the valuation date is treated as the recipient‘s acquisition date for Israeli capital-gains tax purposes.
To apply for this step-up, recipient taxpayers must file Tax Form 905 and certain conditions must be met. The form will be reviewed by the Tax Authority, so a fast-track step-up ruling is still discretionary, not automatic.
If such a fast-track ruling is obtained, overseas capital gains and latent capital gains on the date of the gift/death of the donor will be outside the Israeli tax net, assuming the donor was a non-Israeli resident when he/she made the gift/died. As mentioned, the ruling is available even if no such foreign taxes were paid.
So in the example above, if the house Isaac inherited was worth GBP 1m. upon the demise of Avraham, that figure will be treated as the cost for Israeli capital-gains tax if he obtains a fast-track ruling from the Israel Tax Authority.
If Isaac sells the house immediately after inheriting it, there should be no capital gain for Israeli capital-gains tax purposes. If Isaac waits a few years and sells the house for GBP 1.2m., he will pay Israeli tax on a gain of only GBP 0.2m. Moreover, the Israeli tax rate will be only 20% if the demise of Avraham occurred on or after January 1, 2003.
Since Israel has many immigrants and children of immigrants, gifts and inheritances from abroad are common and the fast-track procedure is welcome news.
Can zero Israeli tax be achieved without a ruling?
Yes, zero Israeli tax is possible if Avraham leaves the house in a testamentary trust for Isaac‘s benefit instead of bequeathing it directly to Issac. The trust must meet all the conditions of a ‘‘Foreign Resident Settlor Trust‘‘ in the Israeli tax law; if so, no ruling is needed from the Tax Authority.
Therefore, in the above example, the GBP 0.2m. gain may be exempt * and so may future gains and income if the trust reinvests the sale proceeds of GBP 1.2m. The foreign tax position should still be checked and specialist advice should be obtained .
As always, consult experienced tax advisors in each country at an early stage in specific cases.
Leon Harris is an international tax specialist at Harris Consulting & Tax Ltd.