Tax Alert No. 17 - 

International taxation  16.12.2013

Tax consequences upon Distribution from a Trust before the End of 2013 - 16.12.2013

Recently, we receive questions related to the newly enacted legislative changes in the Trust’s Taxation Chapter of the Income Tax Ordinance (“ITO“) regarding the taxation and reporting duties of trusts in which there are Israeli beneficiaries- is there any advantage to perform distributions from the trust before the end of 2013?

As already reported, one of the most significant changes in the Trust Chapter in view of the recent legislation, is the cancellation of the favorable tax arrangement for a “Foreign Settlor Trust”- that is, a trust whose settlor is a foreign resident (or who was a foreign resident upon his death), even if it includes Israeli (residents) beneficiaries– and the determination of a more stringent tax arrangement for an “Israeli  Beneficiary Trust” (including a “Relatives Trust”), namely a trust of the aforesaid kind, which has one or more Israeli beneficiaries. Such a trust shall be liable to tax, on part or all of its income, insofar as there is an Israeli-resident beneficiary. The timing of the tax liability and the tax rate applicable shall depend on the type of the trust (a Relatives Trust or a “general” Israeli Beneficiary Trust) and the option which has been chosen. In some of the cases, the reporting duties and tax liabilities apply only at the time of a (taxable) distribution to an Israeli (resident) beneficiary (in a Relatives Trust, in respect of which the option of taxation at the time of distribution “was chosen”).

The Trust Chapter (as per its new  version) is effective from  the  beginning of 2014, so that in all matters pertaining to the actual tax liability in respect of a distribution to a beneficiary, such liability exists (in certain conditions) only from the 2014 tax year and thereafter. One can indeed argue that a distribution from a Relatives Trust which was performed during 2014 or thereafter- shall be liable to tax even if it derives from profits accrued prior to 2014. According to our position, such a distribution out of profits accrued up until 2013 is not liable to tax in this regard. Irrespective of the substantive question pertaining to the tax liability, one of the widespread questions in this regard is whether the distribution should be reported by the trustee or the beneficiary, and in this matter, it is necessary to refer to the date of the distribution.

We shall note that in the most recent legislative changes, it was determined that a beneficiary who received a distribution from a trustee (whether the said distribution is liable to tax or not) is required to file an annual report. Up until the said legislative amendment, the reporting obligation applied solely to an Israeli-resident beneficiary and solely in respect of the distribution of a non-money asset (and even then, only a notice of submission was required, and not an annual report).

As far as we know, the position of the Israel Tax Authority (“ITA“) is that the obligation to file a report due to a distribution from a trust applies to a beneficiary who has received a distribution as of August 1, 2013. On the other hand, it may be argued that in view of the legislation’s wording such reporting is required only regarding distributions performed after December 31st, 2013. That, since the Trust Chapter (as per its new version) applies to income accrued solely after this date, and after all, a distribution to a beneficiary does not constitute income at all, and a fortiori, prior to effective date of the “new” Trust Chapter. We shall note that as long as the reporting forms for the 2013 tax year have not been published, it is not clear what the application is of such reporting duties, or, at least, what the official position is of the ITA in this regard.

There are many trusts which have not been included up until now in the Israeli tax and reporting net, primarily due to their classification as “Foreign Settlor” Trusts. In view of the potential existence of a filing obligation due to a distribution which was made, at the least, after August 1, 2013 (and perhaps even prior to this date) and in view of the expected tax liability in respect of the income which shall be generated commencing from 2014, it is recommended to examine making an application for an arrangement with the ITA in connection with trusts as described above. It is expected that such an arrangement will also include a “step-up” mechanism for the trust’s assets. An outline of the arrangements for trusts has not yet been published by the ITA, however, we expect that it will be published in the near future.

Our firm has extensive experience regarding trusts and the tax liabilities and reporting obligations applicable thereto.

We would be pleased to be of assistance in the relevant cases.

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