Tax Alert No. 15 - 2.4.2013

Recently, the Tax Authority has published a tax ruling and a circular on the subject of fiscal residency of an individual: a taxruling (consensual) that deals with setting of conditions for receiving a certificate of a resident of Israel for treaty purposes, and a circular that deals with the options of receiving prior approval of new immigrant or veteran returning resident status (“beneficiary individual”).

Specifics of the circular – receipt of confirmation of “beneficiary individual” status

The purpose of the circular is to provide certainty concerning the taxation status of a beneficiary individual, which is certainly necessary in view of the extensive relief that is granted to an individual of this status, mainly – an exemption from tax and from reporting concerning incomes and assets outside of Israel for 10 years. According to the apparatus that has been laid down, the applicants will be divided into two groups, in accordance with the level of affinity for Israel as a tax domicile.

Green track: For applicants who have a low level of affinity for Israel as a tax domicile. These will be dealt with at the regional office and will receive approval by shortened proceeding of their eligibility to receive the requested status. If it has been decided that an applicant’s status is not to be approved as requested, the individual may submit an application within the individual track that is set forth below.

Individual track: For applicants who have a relatively high level of affinity for Israel. Their requests will be examined individually (at the regional office in which the file is managed or supposed to be managed, or at the international taxation unit at the headquarters) and a decision concerning their status and date of commencement of Israeli residency will be given by way of a tax ruling. Requests for receiving beneficiary individual status in this track may be submitted in the first stage anonymously. In addition, a specialized form has been established that is suitable for the green track, in which the applicant is required to specify the date on which he became a resident of Israel (if he has already arrived in Israel), declare his compliance with the conditions prescribed in the track, which indicate the absence of affinities for Israel in the 10 years preceding the year of his arrival in Israel or the date of submission of the application (if he has not yet arrived in Israel), as relevant (“the determinant period”), and attach relevant supporting documents.

The conditions that are required for the green track include: absence of a significant stay during the determinant period (up to 90 days per year) of an individual and his/her spouse (the Tax Authority advocates the principle of non-severability of the family cell); in the effective period national insurance fees were not paid, no allowances have been received from the National Insurance Institute and there was no eligibility to receive financed medical care at healthcare organizations or hospitals. There is another alternative to the condition of absence of stay, by which for two non-continuous years out of the determinant period, a stay of up to 183 days in Israel (on the condition that it is not the last year in the determinant period) and a stay of up to 60 days (instead of 90 days in the first option) in each of the remaining years in the determinant period are permitted.

As demonstrated, the strict requirements of the green track deny “entry” to individuals who have a very low affinity for Israel too, such as an individual who has maintained his rights at the National Insurance Institute, even if he did not have a permanent home in Israel and did not stay for even a single day in Israel throughout the determinant period. However, it is not the end of the road for these individuals, who may apply for the individual track.

Tax ruling concerning the issue of fiscal residency certificate for the purposes of the treaty

Spouses who are residents of a treaty country have applied to the Tax Authority in view of their intent to transfer their vital interests to Israel (for the first time) with a request to have conditions set for them whose fulfillment will allow them to be considered as residents of Israel for the purposes of the treaty with their (previous) country of domicile and receive a residency certificate appropriately. The highlights of the decision are as follows:

Spouses will be considered as residents of Israel for the purposes of the Israeli Income Tax Ordinance from the day on which they transfer their vital interests to Israel, as long as they have resided in Israel for a material period from the day of their arrival. The term “material period” was not specified.

Concerning their status as residents of Israel for treaty purposes, a “qualification period” has been set: only at the end of the third tax year from their day of arrival in Israel will the assessment officer issue for them a residency certificate as Israeli tax residents for the purpose of the treaty, retroactively applying from their day of arrival, as long as all of the following conditions have been fulfilled cumulatively:

• The spouses will have a permanent home in Israel.

• In their year of arrival, the spouses will stay for at least 1/3 of their time in Israel; in the second tax year – more than 133      days and in the third tax year – more than 143 days.

• The spouses will declare that they intend to continue to stay in Israel for a period of not less than 143 days in each of the fourth and fifth tax years.

In addition, it has been determined that in each tax year for which a residency certificate will be issued, the spouses are to stay, in each of the other countries, a number of days that is less than the number of days of their stay in Israel during that year.

It appears that by establishing threshold conditions and a qualification period, the Tax Authority is attempting to prevent situations in which foreign residents will arrive in Israel for a short period in which they are likely to yield high incomes (such as when they are expected to sell companies that they hold), only in order to enjoy an exemption in Israel (as beneficiary individuals) and in their country of origin (as foreign residents) for the same incomes.

It is interesting to discuss the case in which the issue of an Israeli residency certificate is required for a third country, for example for an individual who is a resident of France who has immigrated to Israel and who sells soon after his immigration shares in a Romanian company. That individual may be required to procure an Israeli residency certificate in order for the exemption from capital gains tax in Romania to apply, in accordance with the provisions of the treaty between Israel and Romania. It appears that in such a case, the conditions and restrictions set forth will not apply and the Tax Authority will issue a residency certificate for this purpose.

We wish to put forth before you in summary a number of newsflashes that our office has published on the subject of trusts in the last quarter.

As an introduction to the cases set forth below, it must be noted that the trusts chapter in the Israeli Income Tax Ordinance that took effect in 2006 grants a trust a legal status for tax purposes as of an individual, which is a foreign resident or resident of Israel, in accordance with the classification of the trust in the trusts chapter. The questions that arise from the cases that are set forth below pertain to the special status that has been given to the trust as that of an individual, in the context of various arrangements that exist in the Ordinance.

The eligibility of a trustee to enjoy benefits for foreign residents when Israeli beneficiaries exist

The Income Tax Ordinance grants a number of tax benefits for foreign residents, the most familiar and common of which is an exemption from capital gains tax from the sale of securities. At the same time, there is an anti-planning clause that states that a foreign company that is controlled by a resident of Israel to a rate of 25% or more will not be eligible for exemptions that are given to foreign residents pursuant to the ordinance.

It may be asked whether the anti-planning clause applies in a situation in which a foreign company is held by a trust whose settlor is a foreign resident and whose beneficiaries include a resident of Israel. Such a trust is classified in the trusts chapter in the Ordinance as a “foreign resident settlor trust” that is considered as an individual that is a foreign resident.

It is our position that the provisions of the trusts chapter supersede the anti-planning clause, both because the trust chapter was passed later and it deals in great detail with all matters relating to tax events in trusts, and because the purpose of the passing of the chapter indicates that the whole trust is to be considered a foreign resident, concerning the question of the applicability of the anti-planning clause too.

A trust as a representative assessee in a “family company”

Within our daily work, we have been asked to attend to the question of whether a trust can be a representative assessee in a “family company”.

A family company is a company that is controlled by members of a single family, and the tax regime that applies to it, according to the choice of its shareholders, is a regime of transparency for tax purposes, insofar as its liable incomes and losses are considered to be the incomes and losses of the “representative assessee”, who is the holder of the largest right to the profits of the company. A company that is fully owned by one individual may also be considered as a family company.

According to this approach, any trust may be a representative assessee of a family company because it is considered as a single individual rather than as a cluster of legal entities that constitute it.

According to a more balanced approach, if the settlors or beneficiaries of the trust (as relevant, depending on the type of trust) constitute members of a single family, the trust may be a representative assessee of a family company just as those family members could have been were to hold the shares of the family company directly, insofar as the formation of the trust in this context does not constitute an attempt to evade tax. It shall be noted that the trusts chapter purports to be neutral and not provide a tax advantage or disadvantage compared to the state in which there is no trust, but this principle is not always achieved.

Trust for wealthy trustees

From January 1, 2013, an additional tax is imposed on individuals who have high incomes (more than approximately $220,000 in the taxable year, as of this date), except for certain income items that have been prescribed. It is asked whether the additional tax also applies to a trust, and if so, to which sum of income.

Because a trust has a taxation status of an individual, as set forth, it may be contended that the additional tax applies to it as it applies to an individual. However, in a trust that is a resident of Israel, for example, the income of the trust is considered to be the income of the settlor and if there is more than one settlor (for example an individual and his spouse), in our opinion the income is to be attributed (in the aspect of calculation of the additional tax) to both of them. Thus, if after such an attribution to both, the income of each of the spouses does not exceed the said maximum amount, no additional tax will be imposed.

Another contention is that even if the spouses had an income exceeding the maximum determinant sum for the purpose of the additional tax, the income of the trustee is to be examined separately and not attributed to the spouses due to the absence of an explicit provision. An opposite contention that may be made by the Tax Authority is that the income of the trustee is liable for the additional tax from the first shekel.

Tax ruling on the matter of an underlying holding company

Recently, a tax ruling that deals with the classification of an Israeli company as an underlying holding company was published. The trusts chapter of the Israeli Income Tax Ordinance allows a trustee to keep and manage the trust assets, in part or in full, through an underlying holding company, for which it has been determined that it will be considered as the long arm of the trustee and its assets and incomes will be considered as the assets and incomes of the trustee. As a result of this, such an underlying holding company is not required to submit statements and transfers of assets to it are considered as transfers to the trustee. A number of interesting points that arise from the tax ruling follow:

1. The facts of the case indicate that the only activity of the underlying company, which is fully held by the trustee, is holding and operation of the assets of the trustee. We must point out that these are not requirements pursuant to the Ordinance and the tax ruling does not discuss one of its conditions either. Pursuant to the provisions of the Ordinance, a holding company is not barred from engaging in other activities that are not related to trusteeship and it is not required to be held fully by the trustee either (even if these are usually the cases).

2. One of the conditions of the ruling states that a trustee will not be able to withdraw a request for classification of the holding company as an “ordinary company”. In this case too, we must point out that there is no such explicit restriction in the trusts chapter. However, it may be contended that such a change in classification may involve tax events, such as an event of the sale of the assets of the trustee to the company or an event of distribution to the beneficiaries (although in our opinion, particularly if all shares are held by the trustee, this is not a distribution).

3. A holding company will not be considered as a resident of Israel (because it is not an taxpayer for tax purposes in Israel and its incomes are effectively attributed to the trustee himself) and accordingly it will not receive a residency certificate. An interesting question on this matter is what the treatment of other countries to the status of such a holding company is.