Taxation of Trusts in Israel
Following the major tax reform which transformed the Israeli tax system from a territorial one to a personal worldwide one and which came into force in January 1, 2003, further tax reform legislation was enacted, coming into force on January 1, 2006.
This latter legislation amended the Income Tax Ordinance (“the Ordinance”), particularly in relation to the taxation of trusts (Law to Amend the Income Tax Ordinance (No. 147), 2005).
On August 5th 2013, new legislation was enacted regarding the taxation of trusts (Amendment 197 of the Ordinance),
which came into force on January 1, 2014.
The Ordinance, therefore, now contains the detailed provisions for the taxation of trusts (“the Trust Rules”).
Following is a summary of the main Trust Rules
An arrangement, made in Israel or abroad, according to which a trustee holds the trustee’s assets for the benefit of a beneficiary, whether the law which governs it defines it as a trust or otherwise.
A person in whom assets or income from assets were vested (settled), or who holds assets in trust. Foundations under the laws of the Netherlands, Lichtenstein, Panama, the Bahamas and the Netherlands Antilles, and Establishments and Trust Enterprises (Trust Reg.) under the laws of Lichtenstein are all specifically included in the definition of trustee.
“Company for Holding Trust Assets”
An entity that holds the trust assets directly or indirectly for the trustee and that is specifically incorporated for this purpose. Such underlying company, whether incorporated in Israel or not, is transparent for tax purposes, so that in and of itself it has no liability to tax and has no tax reporting obligations in respect of the income generated by the trust assets which it holds. It cannot engage in active trading.
Transferring an asset to a trustee under a trust without consideration. Vesting by a corporate body is deemed a sale and the assets vested are deemed a distribution of dividends to the shareholders of the corporate body.
A person entitled to benefit, directly or indirectly, from the trust assets or income, including:
- A person entitled to benefit upon fulfillment of a condition or when a date prescribed in the trust documents is reached, save if such condition is the death of the settlor or another beneficiary.
- An unborn beneficiary.
- An indirect beneficiary through a chain of trusts.
- A person who holds, directly or indirectly, one or more of any type of means of control in a corporate entity beneficiary, which is not a public institution.
“Settlor” (i.e. creator, and includes any contributor to the trust)
Any person who vests (settles) an asset upon a trustee, directly or indirectly, including, among other:
- A person who was, directly or indirectly, a substantial shareholder (holds 10% or more of the means of control, which include right to profits) in a corporate entity at the time the corporate entity transferred the asset to the trustee; if such person, or his relative, is a beneficiary of the trust, then the holding of any one of the means of control suffices.
- Any beneficiary under certain circumstances may be deemed a settlor – e.g.: a beneficiary that has become a beneficiary as a result of change of beneficiaries in a trust without an enabling provision to this effect in the trust documents; a beneficiary who is able to control or influence, directly or indirectly, among other, the manner in which the trust is managed, or the appointment or removal of trustees.
- The settlor of another trust, which settled the trust in question.
Liability to Tax
The liability to tax on the trust’s accrued income is imposed on the trustee – resident or non-resident – who is the person assessed but whose accrued income is generally deemed the income of the settlor. As can be seen from the following classifications of the trusts, however, the determination whether or not there exists a liability to tax on the accrued income depends on the residence status of the settlor and/or the beneficiaries, even though in general, it is not the settlor and/or beneficiaries – whether resident or non-resident – who are personally assessed to tax, but rather the trustee.
Classification of Trusts and their Taxation
Israeli resident trust (“IRT”)
- A trust, revocable or irrevocable, in which, at the time it was created, at least one settlor/contributor and at least one beneficiary were Israeli residents, and during the tax year, at least one settlor or one beneficiary is resident; (Primary Definition) or
- A trust which is neither a foreign resident settlor trust, or a foreign resident beneficiary trust, or a relatives trust (see definitions below) (Default Definition).
Taxation of IRT
- Creation/contribution (transfer of assets to trust without consideration) – if the creation/contribution is by an individual, it is not taxable; if by an entity (e.g. company) it deemed a sale and may be subject to capital gains tax.
- Accrued income – since the IRT is deemed resident in Israel, it is fully taxable on its worldwide current income, whether distributed or not, at the highest marginal rate and special tax rates applicable to taxation of individuals.
- Distributions – are taxable or non-taxable as would have been the case if transferred directly from settlor to beneficiary in accordance with the provisions in the Ordinance regarding capital gains tax; i.e. cash distributions are generally not taxable, but distributions of non-cash assets may be taxable if they would not have qualified as a bona fide gift, or if the assets consist of immoveable property situated in Israel, or the distribution of the asset is to a non-resident beneficiary.
Israeli Residents Beneficiaries Trust (“IRBT”)
A revocable or irrevocable trust which (i) from the date of its establishment until the relevant tax year all its settlors are non-residents of Israel, and (ii) during the relevant tax year there is at least one Israeli beneficiary, which is not a Public Purpose Beneficiary.
Taxation of IRBT
An IRBT is taxable as an IRT, but the trustee’s income and assets are deemed the income and assets of an individual resident.
An IRBT in which all the settlors and all the Israeli resident beneficiaries are “Relatives”. “Relatives” means that either (i) the settlor is a parent, parent of a parent, spouse, child or grandchild of the beneficiary, or (ii) the relationship between settlor and beneficiary is that of a sibling, descendant, spouse’s descendants, the spouse of any of the foregoing, sibling’s descendants, parents’ siblings, provided that the assessing officer is convinced (in case of (ii) only) that the trust was settled in good faith and the beneficiary has not paid any consideration for his right in the trust assets; “descendant”: other than child/grandchild.
Upon the death of the settlor – unless the settlor’s spouse at the time of settlement or of any contribution is still alive – a Relatives Trust is reclassified as an IRT for all purposes and intent.
Taxation of a Relatives Trust
Creation/contribution – same as IRT.
Accrued income / distributions – There are two options for the taxation of a Relatives Trust as per the irrevocable election of the trustee within 60 days from formation or conversion: (i) First (default) option – distribution of income sourced outside of Israel to the resident beneficiary is taxed at the rate of 30%. (ii) Second option – the accrued income of the trust sourced outside of Israel, which is allocated for distribution to the resident beneficiary, is taxed at the rate of 25%. Israeli sourced income is fully taxed as in an IRT.
Foreign Resident Beneficiary Trust (“FRBT”)
- An inter vivos irrevocable trust with at least one Israeli resident settlor, in which none of the conditions required in the Primary Definition of IRT had existed, all the beneficiaries during the tax year are identifiable non-residents, and Israeli resident beneficiaries, conditional or otherwise, are specifically excluded in the trust deed.
Taxation of FRBT
- Creation/contribution (transfer of assets to trust without consideration) – is subject to tax as would have been the case if the asset were transferred directly from the settlor/contributor to the beneficiary.
- Current income – as FRBT is deemed a non-resident trust, its accrued income is deemed the income of the foreign resident beneficiary, and is subject to tax in Israel as would be the accrued income of any other non-resident individual; i.e. essentially it is subject to tax only on its Israeli sourced income.
Distributions – not taxable except in the case of distributions of immoveable property that may be taxable under the Taxation of Land Law.
Foreign Residents Trust (“FRT”)
A revocable or irrevocable trust in which:
- In the tax year all its settlors and all its beneficiaries are foreign residents, or all its settlors are foreign residents and all its beneficiaries are Public Purpose Beneficiaries or foreign residents, and since its establishment it had no Israel resident beneficiaries; or
all the settlors have died and all its beneficiaries in the tax year are foreign residents, or all its settlors have died and all its beneficiaries in the tax year are Public Purpose Beneficiaries or foreign residents, and since its establishment it had no Israel resident beneficiaries.
Taxation of FRT
- Creation/contribution – same as in the case of IRT.
- Accrued income – as FRT is deemed a non-resident trust, its accrued income is deemed the income of the foreign resident settlor, and is subject to tax in Israel as would be the accrued income of any other non-resident individual; i.e. essentially it is subject to tax only on its Israeli sourced income.
- Distributions – same rules apply as in the case of IRT.
Testamentary Trust (“TT”)
- Trust created under a Will in which all settlors are testators who were Israeli residents on the date of death.
Taxation of TT
- Creation/contribution (transfer of assets to trust by way of Will) – not taxable.
- Current income – The trustee’s income and assets are deemed to be that of the beneficiary; i.e. if there is at least one resident beneficiary the trust will be deemed IRT, and taxed accordingly. If there are no Israeli beneficiaries, the trust will be deemed a non-resident trust and taxed in the same manner as a FRBT.
- Distributions – If beneficiary is resident, taxable as in the case of an IRT. If beneficiary is non-resident, taxable or non-taxable as in the case of a FRBT.
Change of Classification of a Trust
A trust may change its classification, and hence its tax liability status, from one tax year to another pursuant to any relocation of the settlor and/or beneficiaries. Thus:
- IRT that ceases to be as such because it no longer meets the required conditions and becomes a FRT will be subject to an exit tax in the same way as a resident who emigrates. If it becomes a FRBT, the trustee will be deemed to have sold the assets to a non-resident on the day the IRT ceased to be as such and will be subject to capital gains tax under the provision of Part Five of the Ordinance.
- FRT ceases to be as such and becomes a Relatives Trust if one of its beneficiaries becomes an Israeli Resident, or becomes an IRT if one of the settlors becomes an Israeli Resident; in both cases, if the resident is personally eligible to new or returning resident tax exemptions, then such exemptions will also apply to the taxation of the current income of the trust or the distributions, as the case may be.
- FRBT ceases to be as such and becomes IRT if one of the beneficiaries becomes a new or returning resident, and in that case, new or returning resident tax exemptions will apply to the trust in the same way as if the income were accrued to such beneficiary directly.
January 5, 2014
The purpose of this memorandum is to provide a summary and general view of the subjects discussed therein. This memorandum is not a legal opinion, and Occidental Trust Corporation, its directors, officers, agents and any person associated or involved with it disclaim all responsibility as such. Anyone wishing to act in connection with any of the subjects in this memorandum should seek competent professional advice before doing so and should not rely on the contents of this memorandum alone.