The Israel Tax Authority published on March 9, 2014 Transitional Arrangements (“the Arrangements”) regarding the taxation of Israeli Resident Beneficiary Trusts (“IRBT”).

The Arrangements were published pursuant to the recent Amendment (Amendment 197) of the Income Tax Ordinance (“the Ordinance”) which, in substance, imposes taxes on the income of trusts where the settlor is a non-resident, or was non-resident upon his decease, and at least one of the beneficiaries is, or was in the past, an Israeli resident, i.e. an IRBT. The Amendment relates to income accrued as of January 1, 2014 (“the Commencement Date”), and relates to trusts whether created before or after the Commencement Date.

As stated in the Arrangements, their purpose is to provide parameters for the taxation of IRBTs in respect of income earned between January 1, 2006 and December 31, 2013 (“the Relevant Period”) or as an alternative in respect of the adjusted value of the Trust’s capital on December 31, 2013,  where there is doubt as to the tax-exempt status of the IRBT (known as a Foreign Resident Settlor Trust during the Relevant Period), because of one kind of influence or another, de facto or de iure, exerted by the resident beneficiaries. In certain cases, the Arrangements also will enable a step-up on the value of the trust assets as of the Commencement Date.

Following is a brief summary of the main points of the Arrangements:

1. Eligibility – Only IRBTs which qualify as Relative Trusts (or would qualify as such if the settlor had been still alive) are eligible for the Arrangements. Relatives Trusts are IRBTs in which there is a first degree or second degree (with some amplifications and qualifications) relationship between the settlor and the resident beneficiaries. Moreover, there are some other conditions which serve to disqualify even a Relatives Trust, from being eligible for the Arrangements: e.g. the resident beneficiary is also the settlor, directly or indirectly.
2. Tax Options – The default option is the taxation of part of the income – between one third and two thirds – during the Relevant Period at the normal tax rates (generally 20-25%). Under certain circumstances, upon application, the capital, instead of the income, may be taxed at rates ranging between 3-6% of the capital. “Capital” refers to the value of the assets on December 31, 2013 plus all the distributions made during the Relevant Period.
3. Factors determining the income parameters – The following are examples of factors which will increase the part of the income to be taxed: The settlor is no longer alive; the beneficiary had certain powers or authority in respect of the beneficiaries, the trustee or the administration of the trust; the beneficiary transferred assets to the trust for incomplete consideration; the beneficiary received a loan below market conditions/ not according to the Arm’s Length principles and not in accordance with the provisions of the trust deed.
4. “Clean” Trusts – The Arrangements provide that only where the assessing officer is convinced beyond all doubt of lack of influence, i.e. mainly in cases where the non-resident settlor was alive throughout the whole Relevant Period and the resident beneficiaries were either minors or constituted 10% or less of all the beneficiaries – then the trust will not be subject to tax and the assets will enjoy a step-up valuation for the purpose of future taxation. (Note: the Ordinance does not ordinarily provide step-up valuation on the Commencement Date).

In general, the Arrangements allow the assessing officer very broad discretion in deciding how prejudicial the influence of the resident beneficiaries is upon the tax liability of the trust. The examples stated are by way of guidelines only.