The Israeli Tax Authority published recently new guidelines offering special transitional arrangement to certain trusts that had previously been exempt from Israeli tax and became subject to tax from 1 January 2014. Trustees who wish to apply for the tax arrangement and pay limited tax to resolve the Israeli tax position of a trust must do so by 31 December 2014.
See also: New Israeli Tax Regime for Trusts
Amendment to Israeli tax law
The New Israeli Tax Regime for Trusts has caused certain trusts (Foreign Settlor Trusts) that were exempt from Israeli tax to become subject to tax in Israel. Prior to the recent amendment, Foreign Settlor Trusts were treated as foreign residents for tax purposes and only taxed in Israel if they had Israeli source income. Following the amendment, effective basically on 1 January 2014, these trusts became subject to tax in Israel.
Guidelines by the Israeli Tax Authority
The guidelines published by the Israeli Tax Authority provide a set of rules for tax settlement arrangements for such trusts that were previously tax exempt in Israel.
The guidelines allow the effected trusts the possibility to settle their tax liabilities voluntarily by paying a certain amount in tax payments. The exact amount of tax payment depends on a set of issues described in the Israeli Tax Authority’s guidelines.
The settlement routes
The Israeli Tax Authority’s guidelines offer trustees the option of choosing between three settlement routes as follows:
1 - The no-tax route. This path may be relevant if there is no beneficiary control or influence on the trustee.
2 - The taxation of income route. In this alternative, a calculation must be done regarding tax liability had the trust been fully taxable in Israel during the years 2006-2013. Depending on the circumstance, as described below, a portion of that tax liability is then paid to the Israeli Tax Authority.
3 - The taxation of capital route. This alternative requires a trust to pay the Israeli Tax Authority a fixed percentage of the fair market value of its assets as of 31 December 2013. Depending on the circumstance, as described below, a portion of that tax liability is then paid to the Israeli Tax Authority.
The most important advantage of the third route - the taxation of capital, is that a step-up basis is obtained in the assets owned by the trust. On the contrary, under the second route - the taxation of income, a deemed sale of assets needs to be realized in order for a new basis to be obtained.
One of the main factors that will determines the tax relief is the beneficiary influence on the trustee. In certain circumstances in which the Israeli Tax Authority are convinced that the beneficiaries were unable to influence the trust, a settlement arrangement can be reached without any upfront tax being owed. However, if there is influence, the tax liability under the taxation of income route will generally be between 1/3, 1/2 and 2/3. Under the taxation of capital route, the percentage of the trust's capital which is due will generally be between 3%, 4% and 6%.
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