The newly published income tax circular on taxation of trusts includes many provisions on taxation of trusts, and the Israel Tax Authority’s interpretation to a major part of them. It appears that the Tax Authority is highly suspicious with regard to cases in which, in the past, Israelis were beneficiaries in trusts, and the guideline throughout the circular in such cases was that removing an Israeli beneficiary from the list of beneficiaries in a trust apparently constitutes illegitimate tax planning. In several sections in the circular, the Authority clarifies to whom its approach applies, i.e. the definition of a beneficiary in a trust.

• Referring to the definition of a beneficiary, it is written that: “A person shall be considered a beneficiary in a trust, whether he received an actual distribution from a trust or whether he is or was in the past registered as a beneficiary in the trust documents.”
• With regard to a Non-Israeli Resident Trust, it is written that: “In cases in which a beneficiary in a trust was once a resident of Israel, and that beneficiary passed away or ceased to be a resident of Israel before the tax year of 2003…” The trust shall be classified as a Non-Israeli Residents Trust, despite the fact that there was once a resident of Israel in it”; and further on it is written: “…When in a trust there was once a beneficiary, a resident of Israel who, in the wake of a change in the provisions of the trust documents ceased to be a beneficiary in the trust, the trust shall not be classified as a Non-Israeli Residents Trust rather as an Israeli Residents Trust or Relatives Trust…”.

When examining the provisions of the Income Tax Ordinance defining the beneficiary in a trust as “a person entitled to benefit, directly or indirectly, from the trustee’s assets or income, including those…”, one could conclude that the aforementioned assertions by the Authority are not grounded on existing legislation. The law makes no mention of the assertion that a beneficiary remains a beneficiary in the trust, even after having been removed from it.
Furthermore, this assertion by the Authority is in contradiction to the general trust laws that enable removal of beneficiaries, at the discretion of the trustee or creator, or with the fulfillment of certain conditions. Thus, for example, in many cases the spouse of a main beneficiary is included as a beneficiary in the trust, for as long as the couple are married; hence, in the event of divorce the spouse shall cease to be a beneficiary. If the removed beneficiary was a resident of Israel, would the trust still be considered an Israeli Resident? Is the passing of the removed beneficiary the only remedy for fixing the Israeli status of the trust? Here we have a motive in a potential homicide case…
This decision by the Authority as to who a beneficiary is, could create a number of absurd situations: According to the circular of a trust whose creator is a foreign resident, which on the day of formation had two beneficiaries, one non-Israeli and the other Israeli, and in 2004 the Israeli beneficiary transferred his residence to a foreign country; this trust shall still be considered an Israeli Trust (Relatives Trust) despite the fact that for the last 13 years there has been neither an Israeli creator nor an Israeli beneficiary! A similar law shall apply in a situation in which an individual creates a trust for his own benefit, and subsequently severs his Israeli residency. According to the Tax Authority’s approach it looks as though the trust shall continue forever to be “Israeli”.
In several examples included in the circular, it appears that the Tax Authority rejects the status of non-Israeli residence for a trust, due to a past Israeli characteristic. The aim, apparently, is to preclude potential cases of artificial transactions through categorical decisions, without the need to cross the hurdle of proving the fact that the taxpayer has carried out an artificial transaction.
On this matter, it is clear that change of residency cannot disguise itself as tax planning. This would be comparable to an individual leaving Israel and the Tax Authority deciding that he shall forever be considered a resident of Israel, since the very change of residency constitutes tax planning, designed to reduce his taxable income in Israel.