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 and residence of a trust were determined by the settlor ("creator") of the trust – an Israeli resident, therefore the trust was deemed an Israeli tax resident and was taxable in Israel on incomes outside Israel; in case of a foreign resident – the trust was deemed a foreign resident and was tax-exempt on incomes outside Israel.
As a result, the trust of a non-resident settlor was exempted from tax and reporting in Israel, regardless of the country of residence of its beneficiaries. The exemption for a trust created by a non-resident settlor was being given across the board and applied even if all the trust settlors have died and all the beneficiaries were Israeli residents.
In 2014, the law on trusts was changed and, since then, the trust's tax liability also depends on the place of residence of the trust beneficiaries and not solely on that of the settlor. Such dramatic legislative changes require precise planning when establishing and managing a trust in order to avoid excessive taxation in Israel.
In the past, the trust of a non-resident settlor was broadly tax-exempt in Israel (excluding Israeli assets); however, with Amendment no. 197 to the Income Tax Ordinance, the legislator repealed the tax arrangement applicable to a foreign-settlor trust and instead added two classes of trusts:
Foreign Resident Trust – In this trust, all settlors and beneficiaries are foreign residents, therefore the trust is deemed a foreign resident for Income Tax Ordinance purposes and is not taxable on its incomes from assets outside Israel.
Israeli Beneficiary Trust – a trust in which the settlor is a foreign resident, and one or more beneficiaries are Israeli residents. There are two classes of an Israeli Beneficiary Trust:
· A Relative Trust-type Israeli Beneficiary Trust – a trust in which there are family relations between the settlor and the beneficiaries, and it will be considered a Relative Trust until the date in which the settlor and their spouse die. Upon the death of the settlor and their spouse, this Relative Trust will be re-classified as a Non-Relative Trust-type Israeli Beneficiary Trust. Relative Trusts may choose between two tax models for incomes generated outside Israel: a current tax model of 25% tax on the portion of the Israeli beneficiaries, or a distribution model requiring the Israeli beneficiaries to pay 30% tax on any distributions made by the trust.
· Non-Relative Trust-type Israeli Beneficiary Trust ("Israeli Beneficiary Trust") – a trust in which the settlor is a foreign resident, the trust has one or more beneficiaries who are Israeli residents, but there is no family relations between the settlor and all the beneficiaries, or in which the settlor and their spouse died prior to or during the relevant tax year. An Israeli Beneficiary Trust will be considered an Israeli resident for tax purposes and therefore will be table on all its incomes outside Israel during the tax year in which such incomes were generated.
The classification of a trust as an Israeli Beneficiary Trust does not depend on the composition of its beneficiaries: even if the majority of the trust beneficiaries are non-residents, the classification of the trust as an Israeli Beneficiary Trust will result in all trust incomes being taxable in Israel. The taxation of an Israeli Beneficiary Trust as an "Israeli resident" de facto imposes full tax liability in Israel on trusts, even if the source of capital originates outside Israel, if they generate income outside Israel, and if most of the beneficiaries are foreign residents.
Trust legislation establishes a legal situation inconsistent with the spirit of the Income Tax Ordinance and Israeli tax laws. Foreign-resident beneficiaries will be taxable in Israel on incomes generated outside Israel. Had they held the same assets directly, they would be exempted from related tax and reporting in Israel.
Yanay Noyman, CPA (Jurist), specializes in trust taxation and oversaw trust taxation cases, both while working at the Israeli Income Tax Authority, and later as a representative of trusts before the Israeli Tax Authority. The firm advises trust settlors, trustees, and beneficiaries on proper planning and establishment of trusts, uses of trusts, trust management, and aspects of trust taxation, including reaching solutions and complex trust structures, and arranging tax liabilities with the Tax Authority.
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