I. General Overview
The Law to Change the National Priorities (Legislation Amendments to Achieve Budget Goals for 2013 – 2014) came into effect on August 1st 2013. The Taxes Chapter therein constitutes Amendment no. 197 to the Income Tax Ordinance (hereinafter: “the Law” and/or “the Amendment” and/or “the Ordinance”, respectively). Within the Law, the provisions of Chapter Four “B”, Part 2 to the Ordinance (hereinafter: “the Trust Chapter”) and the reporting duties stipulated in section 131 to the Ordinance were modified.
The material change in the Trusts Chapter is with respect to the taxability of Trusts in which the Settlor is foreign resident, or who was a foreign resident when he passed away, that have or used to have at least one Israeli resident Beneficiary (hereinafter: “Israeli Beneficiary Trust”).
The Amendment applies with respect to revenues generated by Trusts as said starting on January 1st 2014 (hereinafter: “the Beginning Date”), whether the Trust was established before or after the Beginning Date. For this purpose, “Settlor” and “Beneficiary” – according to the definition thereof in sections 75D and 75E to the Ordinance, meaning, including an indirect Settlor or an indirect Beneficiary in a Trust through a chain of Trusts or through a different Beneficiary.
2. The Transition Arrangement
2.1 The Beneficiary’s Influence
Under section 75D(a)(4) to the Ordinance, a Beneficiary in a Trust is viewed as a “Settlor” in such a Trust if the Beneficiary has the ability to control or influence the way the Trust is managed, the Trustee’s assets, determining the Trust’s beneficiaries, appointing or replacing the Trustees, the distribution of the Trust’s assets or the inclusion of the Trustee among the beneficiaries, directly or indirectly, among other things.
In addition, in the event that the Settlor passes away, section 75D(a)(3) explicitly determines that changing the beneficiaries in a Trust or changing the Trustee, when there is no explicit instruction to do so in the Trust deed will cause the Beneficiaries to be classified as “Settlors” therein. Classifying a Beneficiary who is an Israeli resident as the “Settlor” of a Trust will result in classifying the Trust as an Israeli Resident Trust, independent of the other Trust Settlor residence, in the same Trust, even before the Beginning Date and Amendment No 197 to the Ordinance.
In light of that said, disputes regarding these Trusts tax liability in Israel may appear, creating the need to determine a tax arrangement (hereinafter: “the Transition Arrangement”) that will take the Beneficiary’s level of influence into account and enable certain transition to the new tax regime while encouraging Trusts to report their income in Israel.
A Trustee who will be chosen at the beginning of the said arrangement will have to arrange the Trust’s tax liability absolutely and finally by the Beginning Date, thus determining a new cost basis for the Trust’s assets, in appropriate cases.
2.2 Inapplicability of the Transition Arrangement
When a Trust in which there are no family relations between the Settlor and the Beneficiaries is concerned, as said in alternatives (1) and (2) to the definition of a “Relative” in section 88, the Transition Arrangement shall not apply and the tax liability in the Trust shall be determined under the provisions of any law and arranged by the assessment officer according the case’s concrete circumstances.
Due to the difficulty in determining a Beneficiary’s level of influence, and desiring to avoid uncertainties regarding the tax liability of Trust that will be classified as “Israeli Beneficiary Trust” in Israel after the Beginning Date, with respect to income that will be generated or accrued before the Beginning Date, a Trust as said may be included in the Transition Arrangement, provided that none of the following is true for it (hereinafter: “the Denial Conditions”):
The Trust may be classified as an Israeli residents Trust before the Beginning Date, by the power of section 75D(a)(5) to the Ordinance.
The Beneficiary is also the Settlor of the Trust, directly or indirectly.
The source of the Trust’s capital is income that was taxable in Israel and no tax was paid due to it in Israel.
A signed declaration of the non-fulfillment of any Denial Condition will be given both by the Israeli resident Beneficiary and by the Trustee in the relevant Trust.
2.3 The Transition Arrangement Programs:
Considering the difficulty in determining the Trust’s Beneficiary’s level of influence and the various possible levels of influence, a Trust that will choose to be included in the Transition Arrangement will be obliged to pay taxes for some of its taxable income in the determining period as specified in the arrangement and in accordance with applicable tax rates according to the law. If the return on the Trust’s capital is not abnormal, and based on the applicant’s request, the assessment officer may tax the Trust’s capital as an alternative means of collecting taxes due to the Trust’s taxable income prior to the Beginning Date.
For this purpose, the “Trust’s capital” – the value of the Trust’s assets for the day before the Beginning Date and distributions that were made to the benefit of Israeli resident beneficiaries on the period between 1/1/2006 and the Beginning Date (hereinafter: “the Determining Period”). The Trust’s capital will include all Trust’s assets, including money and money equivalent, and the Trust’s liabilities toward third parties, the Trustee, the Settlor or the Beneficiary will not be deducted from it. Let it be clarified that the stipulation that liabilities will not be deducted from the Trust’s capital lies with the concern for double benefits, as Trust liabilities often reflect the Trust asset’s original cost.
The tax rate that will be imposed on taxable income or on the Trust’s capital under the arrangement is derived from the Trust’s Beneficiary’s potential level of influence. This level of influence depends on the Trust’s specific characteristics and on the function the Beneficiary fulfilled in the Trust. It is clarified that choosing to apply the arrangement is voluntary. The provisions of Chapter Four “B” shall apply literally to Trustees who will choose not to implement the arrangement on the Trustee’s income in a Trust.
The different Trust taxation programs within the Transition Arrangement shall be specified below. These programs were determined according to the Trust’s Beneficiary’s potential level of influence and they offer alternatives for taxing the Trustee’s income in the Determining Period or taxing the Trustee’s assets.
2.3.1 Taxing the Trustee’s Income in the Determining Period
The Trustee may choose to assume tax liability for some of the taxable income that generated or accrued by the Trustee in a Trust during the Determining Period (hereinafter: “the Part of the Taxable Income”), as specified below. In such a case, the provisions of any law shall apply to the Part of the Taxable Income and the Trustee’s income shall be taxed according to the tax rates determined in the Ordinance and in accordance with the classification of the income’s source.
The Part of the Trustee’s Taxable Income will be converted to ILS according to the USD exchange rate on the last day of the tax year it generated or accrued on, or in accordance with the USD exchange rate on December 31st 2013, according to the lowest.
Losses intended to be transferred for tax purposes that were accrued in the Trust at the end of the 2013 tax year will not be allowed in the set-off in the following tax years. Losses generated for the Trustee during the Determining Period will be allowed in the set-off against the Trustee’s income that was generated in the Determining Period alone, subject to the Ordinance’s provisions.
Foreign tax credit will be given due to the tax that applies to the Part of the Taxable Income in Israel that became taxable within the arrangement, in accordance with the provisions of part J, chapter 3, article B to the Ordinance, at the amount of the creditable foreign taxes, multiplied by an equal ratio to the Part of the Taxable Income in the Determining Period, divided by all of the Trustee’s income during the Determining Period.
The tax that shall apply to the Part of the Taxable Income will bear interest and linkage differentials as defined in section 159a(a)of the ITO, from the end of tax year the income was generated in to the time of the actual payment. It is clarified that no taxes by the power of the second chapter of part J to the Ordinance shall be imposed on the Trustee.
For the avoidance of doubt, it is clarified that in this program, no revaluation for tax purposes (step-up) will be given for the Trustee’s assets as defined in section 75c to the Ordinance while calculating the capital gains from the sale thereof by the Trustee or the Beneficiary, or to calculate due depreciation.
However, insofar as the Trustee will choose to pay the tax on the theoretical sale of the Trustee’s assets, according to the difference between the assets’ original price and their value on December 31, 2013, and according to the rate of taxable income under the arrangement and tax rates stipulated in the law, new purchase date and purchase value will be determined for the assets upon their actual sale, according to the date December 31, 2013 and the determined value for that day.
2.3.2 The Trust’s Capital Taxation
In appropriate case, if the return on the Trust’s capital is not abnormal, and based on the applicant’s request, the assessment officer may tax the Trust’s capital. In this program, a new purchase date and a new original cost shall be determined for the Trust’s assets (hereinafter: “the New Purchase Date” and “the New Original cost”). The New Purchase Date will be the day before the Beginning Date (December 31, 2013), and the New Original cost will be the consideration (as defined in section 88 to the Ordinance) that would have been determined in the asset had been sold on the date before the Beginning Date, and that tax due to which was paid within the arrangement.
The New Purchase Date and the New Original cost will be relevant to calculate both the capital gains when realizing the Trustee’s assets and the depreciation. Moreover, it is clarified that the foreign tax credit due to realization of the Trust’s assets in the arrangements shall only be given with respect to the foreign tax that will be paid for the part of the profit constituting the difference between the consideration (the Trustee will receive when it will actually sell the asset) and the new adjusted original price.
It is clarified further that if the Trust was not taxed due to the Trust’s capital as said in the arrangement, the Trust’s assets’ purchase date and original cost will be determined in accordance with the provisions of sections 75F(j) and 75N(d) to the Ordinance, subject to regulations that will be made pursuant to section 75R to the Ordinance.
2.3.2 Definite Trust without influence of an Israeli Beneficiary:
Only in order to apply the Transition Arrangements only, there may be abnormal cases when the Trustee’s assets or income will not be taxed within the Transition Arrangement, and the Trust’s assets will be revaluated for tax purposes (step-up). These cases will only be possible if the assessment officer will be convinced beyond doubt that there was no actual influence or possible influence of the Trust’s Beneficiary, and there were no contacts of any kind between the Beneficiary and the Settlor in anything that concerns the Trust’s issues.
These cases will mostly be limited to Trust in which the Settlor, a foreign resident, was alive throughout the entire Determining Period and all beneficiaries in the Trust are Israeli resident minors; or to Trust in which the Settlor, a foreign resident, was alive throughout the entire Determining Period and the rate of beneficiaries in the Trust who are Israeli residents decreased below 10%. Let it be clarified that a confirmation of lack of influence will only be given if the assessment officer will be satisfied that there are no signs of abuse or of bad faith in establishing the Trust or in transfers therein.
3. Specification of Transition Arrangements for Trusteeships as of 12.31.13
The Trust’s Characteristics
Taxable Income and Tax Rate (*)
A Trust that may be classified as a relative Trust from the Beginning Date on, in light of the relations between the Settlor and the Beneficiary, as parent, parent-parent, descendant and spouse (hereinafter: “First Degree Relations“).
A Trust that may be classified as a relative Trust from the Beginning Date on, in light of relations between the Settlor and the Beneficiary as said in alternatives (1) and (2) to the definition of a relative in section 88 (that are not first degree relations), and the assessment officer was satisfied that the establishment of the Trust and the vestings therein were in good faith and that the Beneficiary has not given anything in consideration for his right in the Trust’s assets (Hereinafter: “second degree relations”).
The taxation of a third of the amount of the Trustee’s taxable income in the determining period (**) in accordance with lawful tax rates (or taxation of 3% of the Trust’s capital)
This program shall apply to Trust in which the assessment officer was not satisfied that the Beneficiary has absolutely no influence on the Trustee or on the Trustee’s assets.
The taxed amount out of the Trust’s capital within the arrangement, and the taxable income that was taxed according to section 75H1(d)(1) (hereinafter: “the Arranged Capital“) will be tax-exempt in the Beneficiary’s hands on the date of the actual distribution.
It is clarified that for distributions originating from the Arranged Capital, no tax charge shall apply, but any distribution in the distribution program will be considered to have first been performed out of the Trust’s gains, accrued from the Beginning Date on.
In addition, the Trust’s assets will be given step-up in the taxable income program as well, provided that they were theoretically sold as explained above.
Any Trust that would have been considered a relative Trust on the Beginning Date if the Settlor had still been alive, whether there are first degree relations or second degree relations, provided only that the assessment officer was convinced that the establishment of the Trust and vestings therein were in good faith, and the Settlor died before the Beginning Date.
Taxation on half (50%) the taxable income in the determining period (**( according to the lawful tax rates (or taxation of 4% of the Trust’s capital)
The time the creator died will be taken into account (the further the date is from the Beginning Date, the greater the Beneficiary’s influence will be assumed to be)(***).
Trust as said in groups A and B above, that exhibit signs of definite influence on the Trustee and/or on the Trust’s assets by the Beneficiary.
Taxation of two thirds (2/3) of taxable income in the determining period (**) according to the lawful tax rates (or taxation of 6% of the Trust’s capital)
Indicators of the Beneficiary’s influence will also include one of the following:
The Beneficiary has powers regarding the determination of Beneficiaries, the Trustee, or the management of the Trust’s assets.
The Beneficiary is a member of the Trust’s investment committee or another executive body therein.
The Beneficiary provides services to the Trust, such as management or counseling services.
The Beneficiary transferred assets to the Trust, for a non-full consideration (not by way of vesting).
The Beneficiary has an executive position in of the companies or ventures that are held by the Trust.
The Trust’s assets are collateral for a loan the Trust’s Beneficiary borrowed, not under the Trust deed.
A loan that was made to the Beneficiary for a period of X years, not under market terms, and not under the Trust deed.
An Israeli resident Beneficiary Trust where there is no first or second degree relation between the Settlor and the Beneficiary.
Regulating these Trust’s tax liability will be determined under the provisions of any law, and arranged by the assessment officer according to the case’s circumstances.
(The assessment officer’s discretion, and with the approval of the International Taxation Unit and the Legal Chamber)
(*) “The Trust’s Capital” – the value of the Trust’s assets on the date before the Beginning Date, including distributions to Israeli Resident Beneficiaries that were made between 1/1/2006 and the Beginning Date (hereinafter: “the Determining Period”). The Trust’s Capital will include all of the Trust’s assets including cash and cash equivalent, and the Trust’s undertakings toward third parties, the Trustee, the Settlor or the Beneficiary will not be deducted from it.
(**) In cases that the Trustee will choose to be taxed on the Trustee’s income that was accrued or generated in the Determining Period, the purchase date and original cost of the Trust’s assets will be determined in accordance with the provisions of sections 75F(j) and 75N(d) to the Ordinance (because the choice of the taxation program according to the Trust’s income does not grant the right to receive a new purchase date and original cost). However, whoever will perform a theoretical sale of the Trustee’s assets as explained above will be entitled to receive step-up due to them for December 31, 2013, subject to payment of the tax on the capital gain according to the relevant program.
(***) A Settlor’s death in 2013 – in this case, we will enable to view the Trust as if it belongs to Group A, to determine the tax rate in the Transition Arrangement only.
Within the implementation of the Transition Arrangement, the following factors will be weighed and considered, among other things:
The existence of foreign resident beneficiaries in the Trust.
Foreign tax liability/ payment of a foreign tax by the Trust or by the Settlor or Beneficiary on the Trust’s behalf.
A Trust that’s considering a resident for tax purposes in a country that is a signatory to an agreement to prevent double tax with Israel, and that is subject to tax in that country.
A Trust whose tax liability in Israel was regulated before.
Trust in which the Beneficiary is a recent immigrant, a senior returning citizen or a returning citizen during the period determining the Trust creation date (new Trusts compared with old ones).
The date the Settlor passed away.
Other circumstances as the assessment officer will see fit.
4. General Provisions
4.1 Within the proposed arrangements, it will be possible to choose a taxable income program in a certain Trust for various assets and/or capital in cases the assessment officer will decide as said above, provided only that the choice as said does not constitute an inappropriate tax decrease. It will be possible not to be included in a certain program concerning specific income or property that belong to the Trust in abnormal, justified cases, subject to the assessment officer’s approval.
4.2 In the taxable income program, foreign tax credit will be given for foreign tax that was actually paid by the Trust, the Settlor or Beneficiary.
4.3 If the Trustee will choose to carry out a theoretical sale of all of the Trust’s assets, credit will only be given for foreign taxes that will be paid in practice and only due to the Part of the Taxable Income that was actually taxed in Israel within the Arrangement on the sale date; It is clarified that for foreign tax that will be paid due an income component that wasn’t taxable in Israel – no foreign tax credit will be given against Israeli taxes under section 201(a) to the Ordinance due to it.
4.4 Liabilities – should not be reduced from the Trust’s capital in general. Insofar as the tax mechanism on the capital will result in double tax, there will be an individual solution.
4.5 Assessment of un-tradable assets will be performed via value assessment (in the absence of such a value assessment, it will be possible to rely on the value determined for estate tax purposes in the foreign country as a basis for calculating the step-up).
4.6 One who wishes to be included in the Transition Arrangement will issue the appropriate request, along with all relevant appendixes, until December 31, 2014.
4.7 The Trustee’s notice of choice of relative Trust income taxation program, according to the designation program or the distributions program (section 75h1(d)(2), (3), as the case may be), will be issued by June 30, 2014.
4.8 If the Trustee will choose to apply the Transition Arrangement to the Trust, the Beneficiary will provide an affidavit, prepared in accordance with the Evidence Ordinance, attesting that he never transferred any asset to the Trust, directly or indirectly.
4.9 The authorized assessment officers for handling the implementation of the transition arrangements are Tel Aviv 1 Assessment Officer (when the Trustee is a foreign resident) and Tel Aviv 3 Assessment Officer (when the Trustee is an Israeli resident).
4.10 In a theoretical sale of all of the Trust’s assets and in the capital program, conversion of foreign currency to Israeli currency will be performed according to the exchange rate as of December 31, 2013. The tax amount following its calculation will be paid while it is index linked and with interest as said in section 159(a) to the Ordinance, from December 31, 2013 to the actual payment date.
4.11 In the taxable income that is not a theoretical sale program, the tax amount will be paid following its calculation shall be paid while it is index linked and with interest as said in section 159(a) to the Ordinance, from the end of each relevant tax year.
All the stated above is a general review only, and it is by no means a legal advice and/or a substitute for legal advice. It is recommended to acquire professional advice in every particular case.
Lior Pick & Co. Law Offices specialize in International Taxation, Tax Planning, Trusts, and Voluntary Disclosure etc.
Lior Pick is the Vice president of the Israeli branch of the STEP organization.
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