The provisions of the ITO state that a loan that an individual who is a “significant shareholder” in a company (one who holds 10% or more of the controlling interest of the company) will be subject to tax at the marginal tax rate applying to an individual (a rate of up to 48% today) instead of the 25% tax rate applying to interest income, or 15% (for a loan that is not index linked).
The provision above basically applies to a relative of the individual too. For example, if the sibling of the individual (hereinafter: the “sibling” and the “Individual”, as the case may be) gives a loan to the company (in which the individual is a shareholder), he will be taxed at the marginal tax rate because he (the sibling) is also considered a significant shareholder.
Assuming that instead of the sibling giving a loan directly to the company held by the individual (who is a relative), the sibling establishes a trust in which he and his family are also its beneficiaries, and that trust gives a loan to the company. According to the definition of a “relative” in the ITO, the trustee is considered a relative of the sibling, because he (the sibling) is a settlor in an Israeli resident trust and/or in a revocable trust. The trustee is not considered as a relative of the individual, because he (the individual) is not the settlor (or the beneficiary) of the trust. It may be argued that the trustee is a relative of the individual, because he (the trustee) is a relative of the sibling and the sibling is a relative of the individual, in the way that a relative of my relative is my relative. However, firstly this has no standing in the wording of the law and this is not its purpose either (otherwise, everyone would be a relative of everyone), and secondly, in a taxation decision that the ITA itself published, discussing the issues of family relation in relatives trusts, the ITA adopted an approach that rules out this argument. The result is that in the case described above, interest that is received for a loan that the trustee (in a trust that the sibling has created) grants, is taxable, in our view, at tax rate of 25% or 15%, as the case may be, and not at the marginal tax rate that would apply in the case of a direct loan.
The limited tax rates above will not apply, when the trust that the individual has created is the one that holds the company and the party giving the loan is that individual. This is because the trustee in that trust is considered a relative of the individual, the settlor of the trust, and therefore their holdings must be counted jointly and it must be determined that the individual is considered a significant shareholder in the company. Another reason for the non-applicability of the limited tax rates is that the individual is to be considered as holding the shares himself, because the provisions of the ITO state that the holding of shares is “including through voting or trust agreements”. By this interpretation, even if the sibling is the one giving the loan, he will still be considered to be a significant shareholder because the individual is considered as an indirect shareholder and their holdings are to be counted cumulatively.