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Israel plans drastic changes to taxation of foreign settlor trusts

Thursday, 23 May, 2013

The Israeli government has published draft legislation that will radically change the taxation of trusts, especially foreign settlor trusts.

The draft was published on 24 April as an amendment to the annual Arrangements Law, to be submitted to the Knesset along with the annual Budget Law. The main proposed amendments are as follows.

At the moment, distributions to Israeli beneficiaries from a foreign settlor trust are currently not subject to Israeli taxes. However, under the new law, either the trust's distributions or its income will be taxed, depending on the trustee's choice. The trust income will be taxed at 25 per cent of the amount allocated to Israeli beneficiaries; alternatively, distributions will be taxed at 30 per cent of the whole amount of the distribution, excluding distributions of the settler's own funds. Distributions will be taxed by default if the trustee does not make the election.

Also, in future, trusts can only be classed as foreign settlor trusts if the settlor and the beneficiaries are close relatives.

Another significant change relates to the death of a settlor. At the moment, if a settlor dies while still a foreign resident, the trust remains a foreign settlor trust in perpetuity. The draft legislation, however, states that the death of a settlor ends the foreign settlor trust, and its income and assets are regarded as the beneficiaries'. Even if only one of the beneficiaries is an Israeli resident, the trust will be classified as an Israeli resident trust subject to Israeli tax. A trust whose beneficiaries are all foreign residents will escape Israeli tax, but its assets will be subject to the Israeli exit tax regime.

The law will also introduce new reporting obligations for trustees and beneficiaries. Trustees must notify the Israeli Tax Authority of the settlors and beneficiaries of new foreign settlor trusts within 30 days of the trust being set up. Existing trusts must be notified within 60 days of the coming into force of the new law. Israeli beneficiaries will be required to notify the tax authorities of any distribution received from a trust, even a foreign settlor trust,

There are also technical changes to the rules for 'underlying companies' - companies that hold trust assets on behalf of the trustee. Such companies will in future only be eligible for tax exemption if they are notified to the Israeli authorities within 30 days of being set up, and are registered as 100 per cent owned by the trustee. They will also be excluded from claiming double tax treaty reliefs.

These and other developments will be discussed further at the STEP Israel 15th Anniversity Conference

Authors: Meir Linzen, Alon Kaplan