On July 25, 2005, an amendment to the Israeli Income Tax Ordinance (the “ITO“) was enacted, Amendment No. 147. Prior to the Amendment, taxation of trusts in cross-border cases was based on general provisions of the Ordinance, dealing with the endorsement or transfer of rights (e.g., Sections 82 – 84 of the ITO).
The 2005 Amendment was an outcome of a highly debated process and numerous references and reports. It has introduced a new trusts tax chapter into the ITO – Chapter Four 2 – that endeavors to adopt into the ITO the main tax law principles in relation to trusts according to Israeli case law, in an effort to provide high level of clarity and a “new order” in this area. This Chapter introduces four “types” of trusts in addition to certain reporting requirements. On the other hand, this Amendment also has triggered a high level of ambiguity and legal doubts in relation to Israeli trusts and this area is still highly debated by tax law practitioners and scholars. The common view is that the Amendment is extremely complicated and it raises many legal as well as practical questions.
The Amendment includes the following trust types:
- An Israeli Residents Trust (IRT);
- A Foreign Settlor Trust (FST);
- A Foreign Resident Beneficiary Trust (FRBT); and § The Testamentary Trust (TT);
The extensive reporting requirements under the current law and mainly the fact that a ” Foreign Settlor Trust “, in which almost all of the parties (i.e., the settlor, the trustee and most of the beneficiaries) are non-Israeli residents, may still be subject to tax in Israel (if certain conditions are met), was highly criticized.
The complexity of the trust law does not allow us to discuss many of the debated issues in a tax alert. However, the following example may illustrate the argument: under Section 75(g), a non-Israeli resident trust may still be considered as subject to Israeli taxation in relation to the trust income, in case the Settlor and one of the beneficiaries were Israeli residents upon the creation of the trust andif one beneficiary remains an Israeli resident. Correlative reporting requirements are also triggered.
Below we highlight the significant developments (including the enactment of regulations):
Recent amendments seem to alleviate some of the mentioned ambiguities. According to the most recent announcement of the Israeli Income Tax Authority (“ITA“), a possible settlement regarding the capital/income of “old trusts”, i.e. those created prior to 2006 may be available. The charge to be imposed under such a settlement is between 4% – 10% (the actual percentage depends on the residence status of the settlor, the beneficiary or the trustee, as the case may be) and is based on the capital value of the trust as to 31.12.2005. Such a settlement may resolve tax liabilities for previous tax years and may provide a “step-up basis” with respect to
assets held under the trust. The final date to submit a request for a settlement is set to 31.10.2008. Please be noted that anonymous application may be filed.
Further, reporting requirements have been eased by requiring a notice to the ITA in lieu of an annual tax return in specific cases. Moreover, the Minister of Finance may use his authority to release a trustee of a trust settled by a non-Israeli resident (FST) from the duty to file an annual tax return if its income is an exempt income under the ITA, or that tax was dully withheld (this issue should be regulated in the near future.
In addition, new regulations recently issued allowing the trustee of an Israeli Resident Trust (IRT) to exclude from Israeli tax basis the portion of the trust’s income and capital gains which are attributed to foreign beneficiaries. For this purpose, the trustee may secure a specific portion of the trust’s income to foreign individual beneficiaries, or alternatively, may amend the tax statements that were already filed (up to 4 tax years). In case the trustee chooses to secure a specific portion of income or gains to foreign beneficiaries, he cannot use the other alternative, i.e., to amend previous tax statements. Both alternatives require that the assets held by the trust be deemed as if they were sold by the settlor to the foreign beneficiaries, in the appropriate portion and repurchased by the trustee immediately thereafter. Israeli taxation (if any) should apply as a result of such sale. The trustee must formally request the application of one of these alternatives.
