The law to amend the Income Tax Ordinance (no. 165) 5768-2008 (hereinafter: “Amendment 165”), published in June 2008, regulates among other things the reporting duties, notices, declarations and requests in connection with taxation of trusts. At the same time, the tax authority in Israel also published the relevant forms.
Amendment 165 to the Ordinance supplements Amendment 147, within which the Fourth Chapter 2 that is concerned with the taxation of trusts (hereinafter: “Amendment 147”) was added to the Income Tax Ordinance.
Amendment 165 actually replaced some of the report submission duties with duties to submitting notices, particularly regarding Israeli resident settlors and beneficiaries. For a trustee in a trust, the duty to submit a report shall only apply to Israeli residents trusts (including trust by the power of a will that is considered an Israeli resident) or for another trust that had revenues or assets in Israel.
Amendments 165 and 147 are valid as of 1.1.2006, for trusts that were created before this date. Let it be clarified that even though there were no specific provisions in the Income Tax Ordinance regulating the taxation of trusts, it was determined that that said does not derogate from the taxation of their income in the relevant cases, even before 12.31.2005.
A number of relevant basic terms determined in the Income Tax Ordinance:
Trust – in accordance with the definition in section 75g of the Ordinance is:
• An arrangement according to which the trustee holds the trusts’ assets for a beneficiary.
• Such an arrangement may be made in Israel or outside of it.
• An arrangement as said will be considered a trust whether or not it is defined as such according to the law that applies to it, or otherwise.
Trustee – a person in whom assets or income from assets were vested, or a person who holds the assets in trust.
The trust’s assets – assets vested o a trustee or that were purchased or received by him.
Beneficiary – the person entitled to benefit from the trustee’s assets or income, directly or indirectly. The following will also be considered beneficiaries in a trust:
• The person who was entitled to be a beneficiary as said upon the fulfillment of a term or the date determined in the trust documents. However, in case the beneficiary’s rights will be conditioned upon the death of the settlor or of another beneficiary, he will not be considered a beneficiary as long as the settlor or the other beneficiary is still alive.
• A beneficiary that was not born yet.
• An indirect beneficiary, through a chain of trusteeships.
• Whoever holds any kind of “means of control”, directly or indirectly, in a trustee that is a corporation and is not a public institute.
Settlor / grantor – a person who vested an asset in the trustee, directly or indirectly. The following will also be considered the trust “settlor”:
• The person who was the “substantive shareholder” (as defined in section 88 of the Ordinance) in a corporation at the time the corporation vested the asset in the trustee [opening for tax planning]
• Whoever held any type of means of control of a corporation at the time the corporation vested the asset in the trustee, and he or his relative are beneficiaries in such trust.
• Should the trustee vest an asset or income in another trustee after the last settlor had died, or in case the beneficiaries in the trusts were changed without ordering it in the trust documents, the beneficiary will also be considered a settlor in the trust according to which the other trustee is acting, or in the trust in which the beneficiaries were changed as well, as the case may be, unless it was proven to the satisfaction of the assessment officer that the beneficiary had no influence on the vesting as said or on the replacement of beneficiaries.
• In case the beneficiary has the ability to control or influence the management of the trust, the trustee’s assets, the determination of beneficiaries not by the power of the settlor’s determination, the appointment or replacement of trustees, or the distribution of the trustee’s assets or income to the beneficiaries, the beneficiary will also be considered a settlor.
• Should an asset whose source is an asset that was transferred from an Israeli resident or a relative of a beneficiary Israeli resident be vested in a trustee in a foreign resident settlor trust, the Israeli resident will be considered a settlor of that trust.
Vesting – transfer of an asset to a trustee in trust, without consideration [opening for tax planning]
The trustee’s income – income produced or yielded from the trustee’s assets.
Division – the components of the division are:
• The transfer of an asset or income by the trustee.
• Such a transfer is to the b or his benefit.
• Such a transfer is made throughout the trust’s existence or at its end.
Asset – any property, whether movable or immovable, and any right or benefit that are contingent or vested; all whether or not they are in Israel.
Foreign resident – for the purpose of the settlor – including a settlor who was a foreign resident at the time of his death.
Israeli resident – including an Israeli resident who is a resident of the area, and for settlors, including a settlor who was a resident or a citizen of Israel at the time of his death as said.
The protector – the person who is authorized to appoint or discharge the trustee, give orders to the trustee, or whose permission is required for the trustee’s actions according to the trust documents.
Irrevocable trust – this is a residual definition according to which any trust not classified as a “revocable trust” constitutes an “irrevocable trust” as defined in the Ordinance, provided only that the assessment officer was given a duly approved affidavit by the settlor and the trustee, stating that the trust is an irrevocable trust (141 Form) on the determined date.
Revocable trust – a basic term for a trust is that the ownership of the trust’s assets is transferred from the settlor to the trustee, and the financial benefit of the asset and its yield is transferred to the beneficiaries. However, if the settlor or trustee will reserve the control / influence of the trustee’s assets and their management in any way, the trust will be considered “revocable”.
When, after submitting the trust deed to the trustee, the settlor still has power (the settlor’s control or ability to obtain control of the assets he transferred to the trust or their yield), the trust will be considered a “revocable” trust.
The Income Tax Ordinance states that a revocable trust is a trust in which at least one of the following is true:
• It has an option to cancel the transfer or return an asset or income from the trustee to the settlor or to his spouse, directly or indirectly.
• The settlor or his spouse is the beneficiary, or they can become beneficiaries.
• It has a beneficiary that is a corporation 10% or more of the means of control thereof are held by the settlor, directly or indirectly.
• One of the beneficiaries is the settlor’s child, who did not yet turn 18 as of the tax year (meaning, a minor) or there is an option to transfer an asset or income to his child as said, directly or indirectly, provided only that the settlor or his spouse are alive.
• When the trustee is the settlor.
• The trustee is the settlor’s relative, unless certain conditions have been proven.
• The settlor or his relative have the ability to guide the trustee’s activity or give him orders on the management of the trust, its assets, the distribution of its income and other substantial matters.
• The identity of one of the beneficiaries is unknown or the identity of a shareholder in a beneficiary that is a corporation is unknown, unless certain conditions have been proven.
• The beneficiaries were replaced or added without an order given of this in the trust documents.
• A duly approved affidavit was not submitted in a 141 Form on the time determined by the manager for the purpose of an irrevocable trust.
Other than the above cases, there are additional provisions in the Ordinance according to which, under certain circumstances, a trust will be considered “revocable”.
Types of Trust (According to the Income Tax Ordinance):
As a rule, the tax arrangements in the Income Tax Ordinance were determined according to the trust classification, to one of each of the following 4 types:
• Trusteeship of Israel residents
• Trusteeship created by foreign residents
• Foreign resident beneficiary trusteeship
• Trusteeship under a will
There are several possible/ potential “tax events” throughout the trust’s life, as follows:
• The date of the vesting of assets in the trust
• The date of growth of gains/losses
• The dates of distribution of profits / assets from the trust
• The dissolution of the trust or the end of the trust’s life
The assessable person and the taxable person in the trust – as a rule, the trustee will be the assessable and taxable person due to the trustee’s income and actions in the trustee’s assets. His income will be determined and calculation in accordance with the provisions of the Income Tax Ordinance and they shall also apply when the trustee is a foreign resident, and even if the trust was established by the power of foreign law or the provisions of a foreign law apply to it. However, several exceptions were determined, in which the settlor / beneficiary will be the assessable and taxable person.
Moreover, the tax rate in which the trustee’s income will be charged will be the maximal tax rate determined in section 212 of the Ordinance. However, when it a special (limited) tax rate was determined for a certain type of individual income, the trustee’s income will be changed on that income, according to the said special rate.
Reports – the provisions of any law would apply to the trustee for the purpose of reporting due to the trustee’s income and assets, unless explicitly stated otherwise in chapter __ of the Ordinance, for the purpose of the taxation of trusts.
Setoff of will be determined the trustee’s losses – such losses may not be set off from the settlor’s or the beneficiary’s income, and the tax applying to the trustee’s income may not be set off against the tax applying to the settlor’s or the beneficiary’s income, unless explicitly determined otherwise.
Also, the settlor’s / beneficiary’s losses may not be set off against the trustee’s income, and the tax applying to the settlor’s/ beneficiary’s income may not set off against the tax applying to the trustee’s income, unless explicitly stated otherwise.
Calculating capital gains when selling an asset by the trustee / calculation depreciation on an asset, by the trustee – when the trustee sells an asset vested in him without consideration, or its vesting was exempt from tax or non-taxable, then for the purpose of calculating the capital gain / the depreciation due to that asset – the original price of the asset (cost for tax purposes), the balance of the original price and the purchase date – as they will be in the hands of the settlor (the person transferring the asset) and the depreciation amount will be the amount the settlor was allowed to deduct as expense due to that asset (in fact, the trustee enters the transferor – settlor’s shows regarding these parameters).
Upon The End of a Trust –
Losses in the hands of the trustee will be classified according to the source of income in the hands of the trustee (according to the sources established in the Ordinance). In addition, for the trustee’s losses transferred from previous years – they will be considered transferred losses (according to the loss source) of the settlor or beneficiary, as the case may be.
Calculating capital gains when selling an asset by a beneficiary (to whom the asset was distributed) / calculation depreciation on an asset as said – when the beneficiary will sell the asset distributed to him as a beneficiary without consideration, than for the purpose of calculating the capital gain / the depreciation due to that asset – the original price (cost for tax purposes) of the asset, the original price balance and the purchase date will be determined – as they will be in the hands of the trustee (the transferor of the asset), and the depreciation amount will be the amount the trustee would have been able to deduct as an expense due to that asset (in fact, the beneficiary will act in the capacity of a transferor –trustee regarding these parameters).
Vesting an Asset by a Corporation –
When a corporation vests an asset in a trust then, in accordance with the provisions of section 75m of the Ordinance, the following provisions shall apply:
• The vesting will be considered a “sale” for the purpose of the Income Tax Ordinance provisions, including everything that follows from this.
• The vested asset will be considered a “dividend” distributed to the only shareholders holding the rights to that corporation, directly or indirectly [tax planning – in this way one can estimate the value of the transferred asset to receive a higher cost for income purposes (depreciation / cost in sale) when the company is not taxable as a foreign company, and/or evaluate the asset for recognition of capital loss – when an Israeli company is concerned].
• A substantive shareholder, directly or indirectly, in the corporation that vested the asset in the trustee, may also be considered a “settlor in trust”.
In our upcoming articles, we will elaborate on the various kinds of trusts, and how Israeli law relates to each type of trust.
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