The new framework

Sunday, 01 September 2013
Meir Linzen, Alon Kaplan and Guy Katz outline Israel’s changes to the taxation of trusts.

This has been a tumultuous year for trusts in Israel. As part of the proposed 2013–2014 budget, the government submitted a Bill that included vast changes to the way trusts are taxed in Israel. The Bill has been approved by the Parliament’s Finance Committee and passed into law on 30 July 2013. The provisions on the taxation of trusts become effective on 1 January 2014, except for changes to the reporting objectives of beneficiaries, which became effective immediately.

Removal of the foreign settlor trust

The Law for the Taxation of Trusts, enacted in 2005, created a new trust category in Israel: the foreign settlor trust. This was exempt from tax and reporting obligations as long as it did not generate Israeli-sourced income. Under the legislation, trusts settled by foreign residents are generally defined as foreign settlor trusts and treated as foreign tax residents. Foreign settlor trusts retained their status following the death of the settlor, and distributions to Israeli-resident beneficiaries were exempt from tax.

The new law effectively cancels the foreign settlor trust regime by eliminating the status of foreign settlor trust. Trusts settled by foreign residents will be treated as foreign residents only to the extent that all their beneficiaries are foreign residents (now to be defined as foreign-resident trusts). If a trust settled by a foreign resident has Israeli beneficiaries, it will become subject to tax in Israel.

For this purpose, the new law defines a new type of trust that is called an ‘Israeli beneficiary trust.’ This is a trust that:

(i) was settled by a foreign resident who continued to be a foreign resident from the day on which the trust was established until the relevant tax year; and
(ii) has at least one Israeli beneficiary.

To qualify as an Israeli beneficiary trust, the trust should comply with two additional conditions. First, the settlor and the beneficiaries should be ‘first order’ relatives. If the beneficiaries are more distant relatives of the settlor (including siblings), they will require approval from the assessing officer. Second, the settlor must still be alive.

If an Israeli beneficiary trust does not comply with the above conditions (i.e. the settlor has died or the settlor and the beneficiaries are not relatives), it will be considered an Israeli-resident trust and be subject to tax on its worldwide income. If the trust complies with the above conditions, it will be taxed at 30 per cent on distributions to Israeli beneficiaries. The trustee may elect to be taxed at 25 per cent on its current income and gains. The election is irrevocable.

Trusts involving new immigrants

Under current legislation, a trust settled by a new immigrant is entitled to the same tax benefit as the new immigrant (i.e. a ten-year exemption on foreign-source income). These benefits are currently provided even if the beneficiaries are not themselves new immigrants.

The new law narrows this provision such that a trust settled by a new immigrant will be entitled to the tax benefits only if its beneficiaries are also entitled or if they are foreign residents. The new law allows for certain grandfather clauses in this respect.

Trust holding companies

Under Israeli law, a trust holding company (also called an underlying company) is a company whose activities are transparent and part of the trust. The conditions for a company to be considered a trust holding company are not clear in the current law.

The new law creates a detailed new definition of a trust holding company. According to this, such a company must hold trust assets for the trustee, and the following conditions must be met:

(i) the company was established for the sole purpose of holding the trust assets,
(ii) in the case of a trust subject to tax and reporting in Israel, the trust has reported the status of the company within 90 days of the incorporation date (or together with the first annual tax return submitted following the passing of the new law); and
(iii) the trustee directly or indirectly holds 100 per cent of the company’s shares.

The company is not required to submit annual financial reports to the Israel Tax Authority, as the report of the trustee includes activities performed by and within the company.

Beneficiaries’ reporting obligations

An Israeli beneficiary who received a cash distribution was not required to report it to the Israel Tax Authority. Only a beneficiary receiving distributions in kind had to report the distribution. According to the new law, an Israeli beneficiary receiving any distributions must submit a full annual tax return.

Death of the settlor of an Israeli-resident trust

The new law determines that when the settlor of an Israeli-resident trust dies, the trust may be taxed as a testamentary trust, depending on the identities of the beneficiaries. For this purpose, even if the trust has only one Israeli beneficiary, the entire trust will be considered an Israeli-resident trust. 

Author block
Meir Linzen, Alon Kaplan and Guy Katz

Meir Linzen TEP is Managing Partner and Head of the Tax Department at Herzog Fox & Neeman, Alon Kaplan TEP is Managing Partner of Alon Kaplan Law Firm and Guy Katz TEP is Tax Partner at Herzog, Fox & Neeman.

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