Trust Taxation

Israeli Beneficiary Trust

 

In Israel, the taxation of an Israeli beneficiary Trust as an "Israeli Resident" de facto imposes full tax liability on trusts, even if the source of capital originates outside Israel; if the trust generates incomes outside Israel; and if the majority of beneficiaries are foreign residents. Trust legislation establishes a legal situation inconsistent with the spirit of the Income Tax Ordinance and Israeli tax laws. Moreover, foreign-resident beneficiaries will be taxable in Israel on incomes generated outside Israel. Had they held the same assets directly, they would have been exempted from related tax and reporting in Israel

 


 

 

In the past, the tax liability an the residence of a trust were determined by the settlor (or "creator") of the trust–said being a resident of Israel – the trust was deemed a tax resident of Israel and was tax-liable in Israel on its worldwide income; said being a foreign resident – the trust was deemed a foreign resident and was tax-exempt on all its income outside Israel. Thus, the trust of a non-resident settlor was tax exempt and was report- exempt in Israel, regardless of the place of residence of its beneficiaries – in Israel or in any other country. The exemption for a trust created by a non-resident settlor was sweeping and applied also to a situation if all settlors of the trust died and all beneficiaries of the trust were also residents of Israel. In 2014, the law concerning trusts was changed, and from then on, the trust's tax liability is dependent also on the place of residence of the beneficiaries of the trust and not solely on the place of residence of the settlor. These dramatic changes in the law require precise planning in forming and managing a trust in order to avoid excessive taxation in Israel.

If previously, the trust of a non-resident settlor was tax-exempt in Israel in a broad manner (except vis-à-vis Israeli assets), under Amendment 197 of the Income Tax Ordinance, the legislator repealed the tax arrangement applicable to a foreign settlor trust and added, instead, two classes of trusts:

Foreign Residents' Trust – In this trust, all settlors and all beneficiaries are foreign residents, and therefore the trust is deemed a foreign resident for Income Tax Ordinance purposes and is not taxed on its income from assets located outside Israel. Israeli beneficiary trust – a trust with the settlor being a foreign resident, and one or more beneficiaries are residents of Israel. There are two classes of this Israeli beneficiary trust: • Israeli beneficiary trust, Which is a Relatives Trust – in this trust, there is a family unit relationship between the settlor and the beneficiaries, and it will be considered a relatives’ trust until the day the settlor and his spouse die. With the death of the settlor and his spouse, this relatives' trust will be classified an Israeli beneficiary trust, which is not a relatives’ trust. A relatives’ trust may choose between two tax routes vis-à-vis income generated outside Israel: a current tax track at a tax of 25% in relation to the share of the Israeli beneficiaries, or a distribution track requiring the Israeli beneficiaries to pay a tax of 30% on any distributions by the trust. • Israeli beneficiary trust Which is not a Relatives Trust ("Israeli Beneficiary Trust") a trust where the settlor is a foreign resident, and the trust has one or more beneficiaries who are residents of Israel, but there is no family unit relationship between the settlor and all beneficiaries or if the settlor and his spouse died before or during the relevant tax year. An Israeli Beneficiary Trust will be considered a resident of Israel for tax purposes, and therefore will be liable to tax on all its worldwide income in the tax year in which said income was generated. The classification of a trust as an Israeli beneficiary trust is not dependent on the composition of the beneficiaries of the trust: even if the overall majority of the beneficiaries of the trust are non-residents, the classification of the trust as an Israeli beneficiary trust will result in all trust income being taxable in Israel. The taxation of Israeli beneficiary trust as a "resident of Israel" imposes a de facto full tax liability in Israel on trusts even where the source of capital is outside Israel, they generate income outside Israel, and most of their beneficiaries are foreign residents. The trust legislation establishes a legal situation that is inconsistent with the spirit of the Income Tax Ordinance and Israeli tax law. Beneficiaries who are foreign residents will be liable to tax in Israel on income generated outside Israel, while if they had owned the same assets directly, they would be tax-exempt and would not have to report to the Israel Tax Authority.

Yanay Noyman, CPA (Jurist), specializes in trust taxation and has handled trust taxation issues while serving at the Israel Income Tax Authority and later, as a representative of trusts before the Israel Tax Authority. Our Firm counsels tax settlors, trustees, beneficiaries on the appropriate planning and formation of trusts, the use of trusts, trust management, and tax aspects of trusts, including advice and arranging complex trust structures, and settling tax liabilities before the Israel Tax Authority.

 

Please contact us by phone: +97237737070 or by email: yanay@naye.co.il