Following a major reform to Israeli tax law, a trust with a foreign settlor may be taxable in Israel if one of the beneficiaries is an Israeli tax resident. A new law passed by the Israeli parliament introduced the notions of Foreign Residents’ Trust and Israeli Resident Beneficiary Trust. These two will be discusses here.
A trust is an arrangement in which a settlor also known as the grantor transfers various assets to a trustee to administer, for the benefit of other people called the beneficiaries.
See also: Changes in Israeli Taxation of Trusts
The change in law
Under the previous Israeli tax law, a trust settled by a foreign resident was exempt from tax and reporting in Israel on non-Israeli source income. The new law, however, provides that a trust be subject to tax in Israel even if there is only one Israeli resident beneficiary. According to the new Israeli tax law, in such case of an Israeli resident beneficiary, the trust is considered as an Israeli Beneficiary Trust and the beneficiary will have to pay tax on the distribution or income, which is passed to him.
The rational of this change
Israel introduced a new tax regime for trusts only in 2006. However, there was one loophole to the 2006 legislation: Trusts arranged by a foreign resident and Israeli resident beneficiaries, were exempt in principle from Israeli tax on income generated outside of Israel. In order to close this loophole, the Israeli tax law was changed, in effect from January 1, 2014. A trust arranged by a foreign resident with even one Israeli resident beneficiary will be deemed to an Israeli Resident Beneficiary Trust, and consequently will be liable to tax, as discussed below.
Two types of trusts
The former trust is subdivided to two: (a) A Relatives’ Trust – this kind of trust arises if the settlor or the settlor’s spouse are still alive and related to the beneficiary; In such case Israeli tax rates of 25% to 30% are applied; or (b) A fully taxable Israeli Residents’ Trust – this kind of trust arises if the settlor and the settlor’s spouse are deceased and/or are unrelated to the beneficiary; In such case, Israeli tax rates range from 25%-50%.
Reporting to the Tax Authority
In general, a Relatives’ Trust discussed above needs to be notified by the trustee to the Israel Tax Authority within 60 days after it was formed or became such a trust on tax forms 147 (see below about an additional form 154). A pre-2014 Relatives’ Trust should have been notified to the Israel Tax Authority by the end of tax year 2015.
The trustee in this case is considered as the taxpayer regardless of foreign law, unless the settlor or beneficiaries agree to report instead to the Israel Tax Authority. Beneficiaries must still report distributions received from a trust since August 1, 2013.
Form 154 issued by the Israel Tax Authority requires an unchangeable choice to be made between: (a) The distributions option: Israeli tax of 30% on foreign- source income and gains only if it is distributed; or (b) The allocated income track: Israeli tax of 25% on income derived abroad and attributed to Israeli resident beneficiary even though not distributed. If no choice is made, then the distributions track will apply.
The Israel Tax Authority has indicated orally (not yet in writing) that any foreign tax paid on trust income by the trust, the settlor or a beneficiary - will be applied as a tax credit against the Israeli tax. In the case of a negotiated settlement with the Israel Tax Authority, this tax credit is available for both the income and asset routes. In some cases, in which the foreign taxes paid equal or exceed the amount of the Israeli tax that would otherwise be payable, there will effectively be no additional Israeli tax. This is particularly important for grantor trusts under foreign jurisdictions, such as the US, where the grantor pays the trust's income tax. In cases in which no Israeli tax will be due for these reasons, a trustee is still required to register the trust with the Israel Tax Authority by the June 30, 2015 deadline.
New Olim and Returning Residents
A circular by the Israel Tax Authority, dated March 10, 2015, states that for Israeli Residents’ Trusts, there should be, in principle, no Israeli tax or tax reporting so long as the settlor and all the beneficiaries are in their tax holiday or are foreign residents.
Dr. Avi Nov Law Offices, Israeli & international tax law
*this article is intended for informative purposes only and is in no way to be construed as tax advice or a legal opinion