Your Taxes: New Tax Circular on Trusts
The Israeli trust tax regime was first introduced in 2006 and tightened up in 2014. It now aims to tax most trusts with an Israeli resident settlor (grantor) or beneficiary and to neutralize any tax advantage compared with gifts. The location of the trustee is not relevant, but the trustee is usually the taxpayer that must report to the ITA.
If an asset or income is contributed to a trust or if changes are made regarding the beneficiaries, protector or trust documents after the death of the last of the settlors, the ITA may assume an Israeli resident beneficiary used influence in this regard, and deem the beneficiary to be an additional settlor. This would make the trust fully taxable in Israel on all income (if it wasn’t already). The Circular claims that that criteria should be laid down in the trust deed, instead of leaving changes to the discretion of the Trustees.
Comment: This is controversial as the tax law does apparently allow discretion so long as this is what the trust deed allows.
If a beneficiary is removed, he can avoid being deemed a settlor by proving he had no influence over the matter.
If the removed beneficiary later receives trust assets via a gift from another beneficiary, the Circular says this may be artificial or fictitious (i.e. tax avoidance or evasion).
Charities may not count as beneficiaries, unless they are used as conduits for channeling money to a beneficiary or parties related to the settlor.
If an underlying company is wholly owned by a trust for the purpose of holding trust assets, the company may be disregarded for Israeli tax purposes if certain conditions are met. In particular, its purpose should be spelt out in its Articles of Association of other incorporation documents. If the ten year tax holiday for Olim is invoked, the Trustee must be ready to prove these conditions were met 90 days after the tax holiday is over.
More Than One Settlor:
If one settlor contributes cash and another settlor contributes other assets, the ITA claims this may amount to a taxable sale of the other assets.
Relatives’ Trust – Foreign Resident Settlor or Settlor’s Spouse Still Living:
There are detailed rules regarding trusts settled by foreign residents. In particular, the Trustees and Israeli resident beneficiaries can choose between 25% tax on annual trust profits earmarked for distribution to Israeli residents, or 30% tax on income if and when it is distributed to Israeli residents.
In the former case (25% tax), trust income designated for distribution to Israeli resident beneficiaries is taxable in the year it arises, unless losses or foreign tax credits are available or the Aliya tax holiday applies to a beneficiary – calculated on a pro rata basis.
In the latter case (30% tax), an exemption is possible to the extent it is proven the distribution is capital that originates from an asset, including cash that was contributed by the settlor. But distributions are deemed to be income first, then capital.
If a non-financial asset (not defined) is distributed as capital to the beneficiary, it’s cost and acquisition date may be “stepped up” to the value on the date the settlor contributed the asset to the trust.
Such a step-up must be reported to the ITA on tax form 147. Olim may claim the ten year tax holiday on their share of income distributed. A foreign tax credit is available for income – but there is no mention of what happens if income was earned and taxed abroad in one year and distributed and taxed years later in Israel.
Pre-2014 income is taxable unless the trust obtained a transitional tax ruling according to an ITA notice of February 19, 2014.
Comment: Proving capital will necessitate detailed trust accounting.
Death of Foreign Settlor:
The death of a foreign settlor (after 2013) in a trust with an Israeli resident beneficiary will generally make the trust fully taxable in Israel from the date of death.
Death of Israeli resident settlor – estate planning:
The death of the last settlor of a taxable Israeli residents’ trust with only foreign resident beneficiaries may be exempt from Israeli tax if the trust is irrevocable and meets certain conditions (for a Foreign Resident Beneficiary Trust as defined in detail in the law). This is because there is no inheritance tax in Israel. But capital gains tax may apply in other cases not involving the death of a settlor.
Israeli Residents’ Trust:
A regular Israeli Residents’ Trust is taxable on worldwide income and gains in the year derived, at maximum applicable tax rates (15% – 50%). Such a trust is broadly defined.
The ten year Israeli tax holiday for foreign source income and gains of new residents and senior returning residents (lived abroad 10 years) may apply to trust income and gains so long as the settlor and the beneficiaries are each foreign residents, Israeli residents in their tax holiday or charities (see below).
But if the trust became an Israeli Residents’ Trust because the settlor moved to Israel before August 1, 2013 or set up the trust before that date in his ten year tax holiday, the tax holiday should apply to the trust so long as the settlor is alive and in his ten year tax holiday, even if any beneficiary isn’t. Aggrieved taxpayers who feel an injustice may apply to the ITA for relief.
Foreign Residents’ Trust:
This type of trust (as defined in detail) is generally only taxable in Israel on Israeli source income and gains. But it may be taxable on worldwide income if an Israeli resident was ever a beneficiary. The Circular states that this will not apply to a deceased beneficiary or someone that stopped residing in Israel before 2003. Other deserving cases may apply to the ITA for possible relief if their position seems unjust or be contrary to the intent of the law.
Foreign Tax Credit:
Foreign federal or state tax paid on trust income is creditable in Israel, even if the settlor (grantor) paid the foreign tax. This means US tax paid by the settlor/grantor of a US grantor trust may be credited by the trust in Israel.
Israeli real estate:
Separate rules apply to trusts that acquire an Israeli real estate interest. To avoid multiple taxation, it may be necessary to designate and tax the beneficiary ab initio within 30 days, rather than the trust.
Company Contributes Asset to a Trust:
To prevent a tax advantage, the asset contribution will generally be taxed as a sale followed by a dividend, all on a grossed up basis to arrive at the value of the asset so contributed. But if the arrangement is a bona fide business escrow arrangement, preferably by a public company, relief may be requested from the ITA from such taxation.
The Circular clarifies that a nominee arrangement for a principal should not be taxed like a trust for the benefit of beneficiaries.
Unfortunately, there appears to be little or no mention of tax treaties, usufructs, voluntary disclosure (amnesty) procedures, FATCA, or the OECD Common Reporting Standard.
As always, consult experienced tax advisors in each country at an early stage in specific cases.
The writer is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.