On the 1.8.2013, the Law on Changes in National Priorities took legal force (meaning legislative Amendments for the National Budget for 2013-2014) which modifies Part 4 of the Israeli Income Tax ordinance (the “ITO”) and expands its reporting requirements regarding incomes of Trusts that Section 131 of the ITO is applicable to.
As for issues concerning revenues produced by certain trust, the Changes will take legal force from 1.1.2014 (“hereinafter: the “effective Date“).
The main change in the issue related to trusts consists in the tax liabilities of Foreign Settlor Trust established by foreign residents or by a settlor who was a foreigner when passed away, and is applicable to a Trust which enjoys at least one (1) Israeli beneficiary (hereinafter: “Israeli resident Trust“).
In order to avoid conflicts that may arise after the Effective Date, because of the expansion of Israeli tax liability, the Tax Authority announced that in the near future they would formulate some transitional rules.
Furthermore, the Israeli Tax Authority announced that in order to make easier reporting and implementation of the Changes, it will apply regulations designed to put in order the tax requirements for beneficiaries – foreigners or new Israeli immigrants and these regulations will arrange a procedure of the tax exemption for trust established by foreign settlors.
It seems now, in the light of significant changes described below, that Trust’s structure should be revised in such items as classification, scope of beneficiaries, Settlor, assets location, relevant tax obligations and reporting requirements. It should be noted that the listed below legislative changes take force immediately, i.e. starting 1.8.2013.
Briefly, the main changes are as follows:
Foreign Residents’ Trust
Prior to Amendment 197, Article 75.9(1) of the Israeli Income Tax Ordinance stated that “Foreign Settlor Trust” was:
“a Trust, whose Settlors as on the date of creation and taxable year are all foreign residents, or whose Settlors and Beneficiaries in the taxable year are all foreign residents”.
Moreover, a trust established by foreign resident could be “Revocable” or “Irrevocable” trust.
This situation has created an essential tax shelter in the Israeli legislation, which will be significantly reduced by Amendment 197 to the Income Tax Ordinance because of virtual cancellation of the aforementioned type replacing it with new formula: “Foreign Residents Trust” starting on 1.1.2014.
As known, within the period prior to Amendment 197 coming into legal force, trust established by a foreign settlor was completely tax-free in Israel (according to some terms), even after the settlor’s death. Therefore, distributions of “Foreign Settlor Trust” were tax-free for Israeli beneficiaries as well.
Nowadays, due to Amendment 197, such trust will be exempt from income tax in Israel only in case when all its beneficiaries are not Israeli residents.
In cases where trust has been established by foreign settlors but there are Israeli Beneficiaries (one or more), such Trust will become taxable in Israel and will be classified as “Israeli Beneficiaries Trust“.
Thus, an “Israeli Beneficiaries Trust” is:
• Trust established by foreign settlor that continues being a foreign resident from the day of the trust establishment and up to the end of the taxable year, and
• That trust has at least one (1) Israeli beneficiary.
• That Trust can be “Revocable” or “Irrevocable”.
To be considered as an Israeli Beneficiaries Trust, it is required to meet two additional conditions:
1. The Settlor and its Beneficiaries are relatives
The Settlor is considered as relative of a Beneficiary if he (or she) is of first-degree relation, such as spouse, parent(s), child or grandchild of the beneficiary.
when the Settlor is of the second degree relation to the beneficiary (case of broader definition of relationship that includes, among others, brothers, nephews, uncles and aunts), such persons should be considered as “relatives” only to the extent the tax officer is convinced that the trust is created in good faith and the beneficiary does not give any considerations for the rights to the trust’s assets.
2. The settlor is alive
It should be noted that according to the previous law, after death of the foreign settlor – the classification as “Foreign Settlor Trust” became permanent. This situation will be changed after Amendment 197.
It appears from the aforesaid that if the trust does not meet all the above conditions, i.e. the settlor and beneficiaries are not relatives or the settlor is not alive, the trust will be classified as an “Israeli Residents Trust” and will be subject to tax in Israel on any income in Israel and outside of Israel (depending on the residency of the beneficiaries).
If the trust meets the abovementioned conditions, the following rules are to be applied:
• The Trustee is required to notify the tax authorities in Israel that the trust is “Relatives Trust” within 60 days from day of the trust establishment or from the day of the trust becoming a relative trust.
• Tax obligations based on Actual distribution – for Israeli residents, distributions originated from incomes produced or accrued outside of Israel will be taxed at a rate of 30% (on the portion of income from distribution only – subject for approval). In general, distributions that are not from the Capital itself will be first of profits.
When there are a number of beneficiaries, distributions to Israeli beneficiaries will be made according their portion.
• Tax obligations based on Accumulated profits – notwithstanding the foregoing, the Trustee has the right to choose – in a statement submitted to tax authorities within 60 days from the date of the establishment of the trust or from day of the trust becoming a relative trust – that incomes from the trust originated outside of Israel and destined to be distributed among Israeli beneficiaries will be taxed in the year they were produced/ accrued at tax rate of 25%.
A Trustee who choose this alternative will not be able to change it.
• Incomes originated in Israel shall be subject to taxes as usual.
Trust and tax benefits for New Immigrants (and Returning Israelis)
In accordance with provisions of Amendment 168 to the Tax ordinance, trust established by a new immigrant was entitled to the tax benefits (exemption) during the certain period provided for new immigrant. These benefits remained in force even after the death of the new immigrant, i.e. exemption from tax on income originated abroad was valid within 10 years.
These tax benefits were granted even if beneficiaries of a trust were residents of Israel and were not entitled to benefits themselves.
Amendment 197 significantly constricts these benefits saying that after the “aliyah” (a new immigrant first arriving to Israel), the settlor enjoys tax exemptions granted to new immigrants only if all the fund’s beneficiaries are non-Israeli-residents or those who are entitled to tax benefits as new residents.
The said benefits are also valid when a new immigrant establishes a trust after the immigration to Israel and under the above stated conditions, i.e. if all the beneficiaries are foreign residents or if they are also entitled to the New resident’s tax benefits.
Amendment 197 includes a transitional provision whereby the above restrictions shall not apply on Trusts established by new immigrant who immigrated to Israel before 1.8.2013 and as long as the settlor is alive.
Amendment 197 is also applicable to benefits for new residents comprising “Relatives Trust”. In such a trust, all settlors are foreign residents, the beneficiaries or some of them are residents of Israel, and there is family relationship between the settlors and the beneficiaries as stated above. It is stipulated that in case of Relatives-trust, the tax benefits for new residents are applicable according to the proportion of those beneficiaries who are entitled to the relevant benefits.
Public Institution’s Beneficiaries (Charities)
Amendment 197 states that a trust established by a foreign settlor and having single Israeli beneficiary who is a Public Institution Beneficiary, will keep the status of a foreign trust.
That is to say that a trust established by a foreign residents and the settlors passed away, will be tax-free in Israel only if it actually destined for Israeli charity institutions benefiting from the trust distributions or donations.
Term “public beneficiary” includes the state, municipalities, Jewish National Fund, Keren Hayesod – United Israel Jewish Appeal, public institutions, which are tax-exempted in accordance with paragraph 9(2) of the Income Tax ordinance, and similar institutions that are tax-exempted according to the Israeli Law.
Before Amendment 197, the Income Tax ordinance stated that an “underlying company” is a company that holds the trust’s assets on behalf of the trustee directly or indirectly, regardless of its residency; the Income tax ordinance ignored the fact of residency of that company, for tax purposes.
Additionally, it is stated that a property the holding company manages it, belongs to the trustee and the company’s income is considered as that of the trustee.
Moreover, the Underlying Company was not required to file an annual tax report.
According to Amendment 197, “Underlying Company” is a company that holds the trust assets in behalf of the trustee (directly or indirectly) and meets all the following requirements:
• It was established to hold the trust assets only;
• it is required to send notification to the Tax authorities within 90 days since the date of incorporation (or on the legal date of filing the first tax report after publication of Amendment 197).
• The trustee directly or indirectly (through another company) owns 100% of the Underlying company’s shares which are held in accordance with conditions (b and c).
Reporting obligations of beneficiaries
Until the 1.8.2013, Israeli beneficiaries should mandatory report on receiving distributions in kind only (rather than distribution in cash) even if that distribution in kind was not taxable in Israel.
Now, Amendment 197 imposes obligations on Israeli residents of reporting both – cash and in kind, distributions and submitting relevant reports on income in Israel and abroad.
It is important to know that this requirement took legal force immediately i.e. it has been applied to tax reports submitted for the year 2013, and not starting 1.1. 2014.
Taxation of “Israeli Resident Trust” after the settlor’s death
This is determined in the same way as a situation occurred after the death of Israeli settlor: the trust shall be taxable in accordance with residence of beneficiaries. Amendment 197 states that when the settlor of “Israeli residents trust” is dying, the trust shall be taxed according to the identity of beneficiaries as a trust under will of the settlor. In this case, if there is even one Israeli beneficiary, the entire trust is considered as Israeli residents trust.
The aforementioned contains nothing to serve as a legal opinion and/or an alternative to specific legal/ tax advice. We will be happy to be at your disposal for any queries and or explanations regarding this or any general matter. Our office specializes in taxation, Trusts, corporate law, real estate and international transactions.
Lior Pick & Co. Law offices
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