Lior Pick, Advocate (CPA (Isr.)) TEP
In accordance with the provisions of section 75g(a)(1) and (2) of the Ordinance, a trust shall be classified as a “trusteeship of Israel residents” in one of the two following cases:
1. A trust in which all of the following are fulfilled:
• Upon its creation – at least one settlor and one beneficiary therein were residents of Israel.
• In the tax year – at least one settlor or one beneficiary therein were residents of Israel.
2. Residual definition – it is a trust that is not a “foreign resident trust” and is not a “foreign resident beneficiary trust”. Despite of that said, a “trusteeship under a will” will not be considered a trusteeship of Israel residents.
A trust will be considered an “Israeli resident trust” whether it’s revocable or irrevocable.
In a trusteeship of Israel residents, the trust’s assets and incomes will be considered the assets and incomes of the settlor (not including exceptions in which they will be considered the beneficiary’s assets and incomes).
When vesting assets in a trust – the vesting will not be considered a sale (for the purpose of Chapter E of the Ordinance) unless it concerns a settlor that is a corporation, and then, as specified above, the vesting will be considered as a sale the transferred assets by the company and the reception thereof by the shareholder as a “dividend”.
Taxation of the Income of Trusteeship of Israel Residents
An Israeli resident trust is taxable in Israel including all of its income (in Israel and abroad), on an ongoing basis, in the year they were produced / yielded.
The tax rate that shall apply to the trustee’s income is the maximum tax rate for an individual, determined in section 121 of the Ordinance, including specific tax rates for specific income such as: interest, dividend, rent and so on, all without taking into account deductions, credits, setoffs or exemptions.
The exception – should a trust become an trusteeship of Israel residents trust after one of its settlors became a resident of Israel for the first time, a senior returning citizen or a returning citizen – the benefits awarded in the Income Tax Ordinance to senior returning citizens, returning citizens and/or recent immigrants, as the case may be, shall apply to the trustee’s income, in accordance with the provisions of sections 14(a) or (c), 16 or 97(b) or (b3) of the Ordinance. Also, exemptions from the duty to report shall apply as said below in section ____).
in accordance with the position of the tax authorities dated 10.26.2009, a trustee in an Trusteeship of Israel residents or in trusteeship under a will that is considered an Trusteeship of Israel residents, for whom income was produced or yielded outside of Israel, is supposed to report them in ILS after converting the foreign currency amounts in accordance with to the Income Tax Rules (Conversion Of Amounts Whose Source Is Outside Of Israel To New Israeli Shekels), 5764-2003, starting on the report for the 2010 tax year and on.
In accordance with the Income Tax Regulations (Designation Of Income For A Single Foreign Resident Beneficiary And Determining Capital Gain In A Designated Trust) 5768-2008 (hereinafter: “the Designation Regulations”), when a part of the trustee’s revenues and/or assets belong to an individual foreign resident beneficiary in an Trusteeship of Israel residents or in trust according to a will, the ongoing tax liability can be calculated while referring to the foreign resident’s share. So, when the income and/or asset is designated for a foreign resident beneficiary, the tax will be calculated as if the foreign resident beneficiary, not the settlor, is the one who produced the designated income (or sold the designated asset) directly. Accordingly, deductions and expenses made due to the trustee’s income will also be attributed to him, according to the designated beneficiary’s share.
As a condition for this, the trustee must notify the assessment officer that this is a designated trust and that he wishes to apply the Designation Regulations. The calculation as said shall being in the tax year after the year in which the trustee gave notice as said, not including a trust that has given notice as said within 3 months of its establishment [don’t miss].
Note that in light of the application of the Designation Regulations, any vesting of an asset intended for a foreign resident beneficiary will be considered a sale by the settlor, and the tax will be calculated as if the asset was sold directly from the settlor to the beneficiary, the foreign resident.
As a rule, the Designation Regulations will mostly apply to irrevocable trusts.
The Division of the Trust’s Assets
As a rule, the division of the trust assets will be exempt from capital gain tax, similar to a transferred asset that is created directly for the beneficiary (for example – such a transfer will be exempt if it will meet the tests of section 97(a)(5) of the Ordinance – Gift for a Relative, Not Including Transfer to a Foreign Resident). It is well known that there is no gift tax in Israel in general as of the time of writing (not including the transfer of an “asset” without consideration to a foreign resident) and there in no inheritance tax.
For this purpose, the settlor will be considered an “Israeli resident” even if he will have become a foreign resident at the time of division.
Should a trust have several settlors and a transfer from at least one of whom to the beneficiary would have been taxable if it was made directly – the division will be taxable.
Division to beneficiaries who are foreign resident – along with the Designation Regulations, the Income Tax Regulations (Provisions For The Purpose Of Adjusting The Trustee’s Income Assessment And Determining The Capital Gain In His Hands Following A Division To A Beneficiary who is a Foreign Resident), 5768-2008 (hereinafter: “the Assessment Determination Regulations”) have been established, allowing changes in the tax calculation at the time of distributing the money to the foreign beneficiaries.
Despite of the Assessment Determination Regulations, in the tax year in which the funds were distributed to beneficiaries who are foreign residents, the amount attributed to them will be considered the income of the foreign resident beneficiary and not of the settlor.
The Assessment Determination Regulations specify how the calculation will be performed and how the amount attributed to the foreign resident will be divided between the tax year in which the division was performed and up to the 4 years preceding it (but not before the 2006 tax year). The meaning of this determination – adjusting the tax assessment in these years, is retroactive, regarding the trustee’s income, that also included amounts attributed to foreign beneficiaries, and was taxed accordingly, even if a final tax assessment is concerned.
For this purpose, the trustee must ask, within the annual report for the distribution year, to apply the Assessment Determination Regulations.
Let it be stressed that for the purpose of preventing double benefits – should a trustee choose to implement the Designation Regulations, the Assessment Determination Regulations shall not apply to him (for those years).
Division to beneficiaries after the end of the trust – if after the end of the Trusteeship of Israel residents and the distribution of its assets, there are losses for tax purposes in it that have not yet been set off, and if there were profits they would have been taxable in Israel, such calculations will be considered the settlor’s losses. If there were several settlors – the loss will be divided pro rata, according to the value of the assets vested in the trustee at the time of vesting.
A Number of Exceptional Cases:
1. Revocable trust with only one settlor who is an Israeli resident – section 75g(8) of the Ordinance –
In a revocable Israeli resident trust, in which there is only one settlor who is an Israeli resident, the trustee and the settlor can announce (in a 148 Form along with the report in accordance with section 131 for the year the trust was created) of their choice that the assessed person and the taxable person due to the trustee’s income will be the settlor. For this purpose the settlor and his/her spouse will be considered a single settlor.
Let it be stressed that as long as the settlor is alive and a resident of Israel – he cannot withdraw the said request.
In such a case, the provisions according to which the trustee’s income will be taxed with the maximum tax rate applicable to individual residents of Israel. These provisions shall apply as long as the settlor is a resident of Israel.
2. An irrevocable trust in which the trustee’s income was distributed to an Israeli resident beneficiary – section 75g(g) of the Ordinance –
When an irrevocable trust is concerned and the trustee’s income was distributed to a beneficiary who is Israeli resident, the trustee’s income will be considered the beneficiary’s income, and the provisions according to which the trustee’s income will be taxed with the maximum tax right applicable to an individual in Israel shall not apply, and the remaining tax outcomes will change accordingly, upon the fulfillment of all the following terms:
• The distribution was made before the end of 6 months of the end of the tax year in which it was produced or yielded, or until the date of submitting the report for the tax year as said, according to the earliest.
• The income was included in the report submitted by the trustee according to section 131 of the ordinance, as income that was distributed and was not taken into account when calculating the trustee’s income or his taxable income.
• The income was included in the report submitted by the beneficiary according to section 131 of the ordinance, for that tax year.
• The trustee and the beneficiary have attached to the report they submitted (according to the above said) notice in 142 form of the distribution and of their decision to have the distributed income of the trustee considered as the beneficiary’s income.
3. Choice of the “Representative Settlor” as “Assessed Person” and “Taxable Person” –
Despite of the principal that the trustee is the assessable, taxable person, and to assist foreign resident trustees, Amendment 165 to the Ordinance determined that in an Israeli resident trust that does not have an Israeli resident trustee, the assessable and taxable person will be the “representative settlor” who is an Israeli resident, all upon the fulfillment of the conditions in section 75f(1) of the Ordinance, as follows:
• The trustee announced of his choice to apply the section’s provisions, and declared that he pledges to give the representative settlor any information required to him to obtain full knowledge of the trustee’s income or assets.
• For an Israelis residents trust – all settlors including the representative settlor have notified of their choice of the representative settlor as the assessable, taxable person and the application of the section’s provisions.
• Notices by the settlors and the trustee have been submitted in the 144 form within the annual report submitted by the representative settlor for the first tax year in which they elected to apply the section.
• It’s impossible to withdraw from the choice of representative settlor as long as he is alive and a resident of Israel, and there is no Israeli resident trustee in the trust.
Change in the Settlor’s Residency
Should the settlor cease being an “Israeli resident”, the trust will still be considered a “Trusteeship of Israel residents” and the trustee’s income and assets will be considered the income and assets of an individual Israeli resident.
The provisions of section 100a of the Ordinance (Exit tax) shall not apply to a trusteeship of Israel residents on the day the settlor ceased being an “Israeli resident”, as long as the trust will be a “Trusteeship of Israel residents”.
A Trust That Ceased Being a “Trusteeship of Israel Residents” And Changing the Type of Trust
Trust shall cease being a “Trusteeship of Israel residents” starting on the date the terms specified above will not be fulfilled for it.
A “Trusteeship of Israel residents” that became a “foreign resident beneficiary trust” – in the context of part E of the Ordinance, the trustee’s assets will be considered to have been sold to a foreign resident on the day of the change. Similar to the transfer of an “asset” as a gift from an Israeli resident to a foreign resident.
A “Trusteeship of Israel residents” that became a “foreign resident beneficiary trust” – in this case, the provisions of section 100a of the Ordinance shall apply (meaning, an imputed sale of sort will be performed) upon the date of the change, mutatis mutandis.
In our upcoming articles, we will specify on a foreign resident settlor trust, foreign resident beneficiary trust, and trusteeship under a will.
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This circular is intended solely for general purposes. The contents of this circular may not be used without receiving professional individual legal opinion and/or advice pursuant to the specific circumstances.
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