Tax Laws in Israel: Taxation of Trusts
Up until December 31, 2002, the Israeli tax regime was predominantly territorial, certainly with respect to income, although capital gains also carried an extra territorial liability in many cases. As of January 1, 2003, however, the method of taxation in Israel changed from territorial to personal; therefore, any income accruing after that date, irrespective of its original source, is subject to personal taxation, whether or not that income is physically received in Israel. For example, Israeli tax residents earning income sourced abroad are, since January 1, 2003, liable to report and pay tax on that income. Such income, for example, emanates from foreign bank accounts held by Israeli residents, the source of funds being, again by example, from inheritance. When Israel’s tax law regime switched from territorial to personal, it represented a major change that carried with it a whole new and massive set of legislation.
The new tax regime of personal taxation was a result of Amendment 132 to the Income Tax Ordinance–New Version, 5721-1961 (2005) (the
Ordinance). Notwithstanding this, the Rabinowitz Committee on Tax Reform, the forerunner to said Amendment 132, recommended that, since the trust concept did not find expression in the above tax reform, and due to the complexity of the issue of the taxation of trusts, a separate committee should be formed to deal with this issue. Thus, on September 2, 2002, a committee was appointed, and on July 24, 2003, the committee filed its recommendations. As a result, amended legislation providing for the taxation of trusts was passed by the Israeli Knesset on July 25, 2005, and came into effect on January 1, 2006, under Amendment 147 to the
Ordinance (the Amendment). Prior to 2003, when Israelis were taxed on a territorial basis (i.e., not worldwide like today), many wealthy Israelis were hiding behind offshore trusts they set up; essentially, it was thought that if assets were put into a trust, the actual trust would not be subject to tax.
However, that strategy changed because of the Amendment. The Amendment essentially states that the basis for taxation of a trust is where the residence of the settlor is. It should be noted that when dealing with trusts under the Amendment, one is referring in most instances to foreign trusts (not Israeli trusts), since the use of trusts in Israel is not the norm and is still largely embryonic. It has primarily remained the domain of foreigners and new immigrants to Israel who have brought the tradition of of the institution of the trust with them from other jurisdictions,principally common-law jurisdictions.Returning to the basis for taxation of trusts under the Amendment, as mentioned, the core test for determining the tax status of a trust for Israeli taxation purposes is the tax residence status of the settlor of a trust, again bearing in mind that any intending Israeli settlor will probably be advised to set up his or her trust under the laws of some other jurisdiction outside of Israel. In principle, if a trust was set up by an Israeli settlor and the beneficiaries are Israeli, then under the Amendment, the trust has the status of an “Israeli resident trust,” and it is entirely taxed in Israel on both income and capital. However, if a trust is set up by a non-Israeli settlor in favor of Israeli beneficiaries, then provided the beneficiaries do not demonstrate they have control over the administration of the trust and the assets of the trust (e.g., cannot appoint trustees, cannot manage the assets of the trust), then the trust will be exempt from tax in Israel and will be deemed under the Amendment as a “foreign settlor Israeli beneficiary trust.” Additionally, if an Israeli settlor creates a trust in favor of foreign beneficiaries and that trust is “irrevocable” within the meaning of the Amendment, that trust would again be exempt from tax in Israel and would be deemed under the Amendment as an “Israeli settlor foreign beneficiary trust.” What is interesting about the Amendment is that because Israel does not really have a trust law system, and therefore most of the trusts established here are foreign trusts with foreign trustees, we have a unique situation in that many foreign trusts with foreign trustees are being created by Israeli tax residence settlors, and under the
Amendment such trusts are fully taxed, regardless of the fact they may be foreign trusts having foreign trustees with the assets located outside of
Israel. And it is the responsibility of the foreign trustees, in whatever jurisdiction they may be located, to report those assets to the Israeli income tax authorities, and pay the tax.Even though the Amendment came into effect in 2006, the actual reporting obligation has been delayed and stands until the end of this year; in other
words, foreign trustees, in whatever jurisdiction worldwide, who manage a trust with assets outside or inside of Israel that has been established as an Israeli resident trust, are obligated to report the trust assets to the Israeli tax authorities by December 31, 2009. Israeli settlor foreign beneficiary trusts Inside the Minds – Published by Aspatore Books are also reportable (a declaration must be filed by the trustee confirming the trust is irrevocable and has no Israeli beneficiaries), but are not taxed.This tax regime is particularly advantageous for families or high net worth individuals living outside of Israel in cases where a foreign settlor Israeli beneficiary trust is set up. In such cases, so long as the Israeli beneficiary does not demonstrate control over the assets of the trust, the entire trust fund is exempt from tax in Israel. Therefore, if there are families who have relatives in Israel, instead of leaving their assets in their will by way of inheritance to their Israeli family residents, it may be advisable for them to set up a foreign trust and for the trust to receive the assets for the Israeli residents, thereby allowing the entire trust fund to be exempt from Israeli tax.
Tax Exemptions for New Immigrants
Another very attractive and unique Israeli tax law was passed in September
2008, effective as of January 1, 2007, whereby new immigrants and returning Israelis who arrived in Israel after January 1, 2007, receive a full ten-year tax exemption on overseas income and capital gains, in honor of Israel’s sixtieth Independence Day. This law means that anyone who immigrates to Israel post-January 2007 or returns to Israel after having been away a certain number of years, as expressed in the law, receives a ten-year exemption on reporting and paying tax on all passive and earned income from outside of Israel. Simply put, there is no reporting for ten years and no tax rate with respect to pensions, rents, royalties, dividends, capital gains, interest payments, and profits from overseas businesses.Because of this new law, we have seen many very wealthy people, including families of high net worth individuals worldwide, who are taking an interest in immigrating to Israel. Israel has many advantageous tax treaties and a very good tax system, but rarely does a country have a ten- year reporting exemption that makes it a long-term tax haven for new immigrants.However, it is not enough just to immigrate to Israel to take advantage of the ten-year tax holiday. You have to be deemed an Israeli tax resident as defined in the Ordinance, and the presumption that you are an Israeli tax resident is largely based on the number of days one spends in Israel (i.e., New Tax Law Strategies for International Clients with Interests in Israel one must be present in Israel for a certain amount of time—more than 183 days a year—and demonstrate that Israel is the center of your life). This is
specifically of importance if you want to use your status as an Israeli resident to benefit against other jurisdictions, and then you have to demonstrate that Israel is where you permanently reside. Indeed, we have seen a lot of cases involving international individuals who may want to be in Israel less than 183 days a year because they have houses or businesses all over the world, but they still want to be treated as Israeli tax residents and receive all the advantages of the ten-year exemption visa vi other jurisdictions. Consequently, we have been working with the income tax authorities to obtain personal rulings for clients to achieve the tax-exempt
status and basically regulate their status in advance.
Tax Laws Affecting Multinational Companies
Although new Israeli tax law has less of an effect on companies and more of an effect on families and individuals with high net worth, it also affects worldwide trust companies and bank institutions that provide trustee
services to Israeli families, because those entities have reporting obligations in Israel. Our firm deals with inquiries from a number of international trust
companies and banks that offer trustee services; those firms want to know what their reporting obligations consist of, and how they would be
implemented by the Israeli tax authorities.Companies operate under a different section of the Ordinance and other legislation enacted over the years. Israel offers companies that invest in Israel a variety of tax exemptions or preferences, depending on where companies invest. For example, in some transactions, a company might be subject to a much lower capital gains tax, as there are certain exemptions on capital gains for foreign investors in Israel. Indeed, there are several laws to
encourage foreign investment in Israel; the main one is called the Encouragement of Capital Investment Law.
Assisting Clients with Tax Law Planning and Compliance
Fortunately, most of our clients are not encountering any major difficulties in complying with the Israeli tax law. On the one hand, Israel offers a very
enlightened and modern tax system that is properly governed, legislated, Inside the Minds – Published by Aspatore Books and enforced; and on the other hand, it provides a lot of flexibility in terms of foreign investment into Israel.Most of our work centers on assisting clients with international tax planning (i.e., setting up a trust for clients in different jurisdictions, taking into account the residence of the settlor and/or beneficiaries). Obviously, today’s business world is much more transparent than it used to be; a lot of due diligence and compliance is now required. Therefore, we always need to have our finger on the pulse of any changes in this area. It is important to understand how our tax advice and Israeli tax laws may affect beneficiaries or family members in different jurisdictions and vice versa; consequently, it is necessary to work with counsel in other jurisdictions when we are engaged in international tax planning for either companies or families. Also,
since Israel’s adaptation to the worldwide taxation system in 2003, a lot of Israeli families and individuals have had to restructure their asset base in the
best way possible to meet reporting and taxation requirements.
Preliminary Client Meetings
Now that compliance regulations are heavily enacted worldwide, it is more important than ever to obtain key information from our clients. Whenever we are assisting a client with tax planning, we want to make sure of the source of the funds in question. We have a full team of compliance officers who assist us in setting up fund structures or opening bank accounts, and it is always important for us to obtain photocopies of the client’s passports and any other documentation, such as a utility bill that can provide information on how the client’s funds were earned. Some key questions we ask our clients relate to the nature and source of the funds earned, their education and business experience, and their background.
Working with Tax AuthoritiesOur firm has in-house tax counsel and accountants who handle any local tax reporting issues. Usually the process is anonymous to begin with, and if the client is happy with the result, we will then insert the name of the client into a tax agreement to finalize the ruling, and if necessary, pay the tax
agreed upon in the ruling. Typically, there is no interaction between the client and the tax authority; indeed, in many cases, our clients or their New Tax Law Strategies for International Clients with Interests in Israel trustees are located overseas. Consequently, we have been handling a number of trust rulings and reporting on behalf of foreign trustees.Our in-house tax counsel will meet with the relevant tax officers, and then our international tax law team will be involved in the reporting process, engage in ongoing communications with the client, and do any necessary legal research.Managing Client ExpectationsWhen working with clients on trust and tax issues, I find that they typically expect their attorney to have full expertise in this area. Consequently, it is very important for a law firm to have an international tax network and tax counsel, as well as local tax counsel. In today’s world, it is impossible to create a proper tax structure for families and perform international tax planning and asset protection without understanding the laws of other jurisdictions. Having multinational abilities is very important to today’s clients.Likewise, lawyers have certain expectations of their clients. For example, we expect our clients to tell us everything concerning their tax situation. Being fully informed is vital, especially when dealing with local tax authorities, because if an attorney is missing some key information in a client’s tax
matter, it can very much jeopardize the proposed tax agreement and damage the goodwill between the firm and the tax authority. Therefore, it is
important for the client to know that you expect him or her to tell you everything there is to tell.
Common MisconceptionsI find that people are usually surprised at how modern and effective the Israeli tax system is, and how approachable the tax authorities are. At the same time, clients may not know how important it is to clarify certain issues before doing a deal or making an investment into Israel, before immigrating to Israel, or before creating a trust. It makes a big difference if you do things right from the beginning, rather than learning about something when it is too late or after the fact.Indeed, if a client comes to me before investing in Israel, before immigrating to Israel, or before making relevant arrangements for relatives in Israel who are beneficiaries of a trust, they can get the best possible tax advantages Israel Inside the Minds – Published by Aspatore Books has to offer. Conversely, those advantages can be missed if proper advice is not sought beforehand. In many cases, people come to us with tax issues after they have immigrated, and if they had structured their asset protection strategies correctly prior to coming to Israel, they and their family members would have been able to enjoy a larger variety of tax exemptions. For example, many foreigners are not aware that leaving assets to Israeli relatives in trust can provide many tax advantages for those Israeli relatives.
Key Tax Violations in IsraelFailure to report and failure to pay income tax are criminal liabilities in Israel. Therefore, even if you do have a tax problem, it is always better to come to the tax authorities before they come to you, and try to settle the matter.
When Israel changed its taxation system to a worldwide system, it represented a major change that has led to the creation of many important new tax laws, especially the new laws concerning the taxation of trusts, and the law giving new immigrants full reporting and tax exemptions on worldwide income and capital gains for ten years. Israel is now on the map in the international tax arena, in that it has a lot to offer to investors or high net worth families who wish to settle here.Israel has always attempted to accommodate foreign investors by offering reduced taxes on some transactions, and we can help our clients take advantage of those tax laws. In addition, there is always a need for asset protection, and the current economic crisis has made high net worth individuals realize how much they need correct asset structuring to protect their family fortune. That is another area where we provide assistance to clients.I would advise all lawyers in this practice area to join international tax associations, engage in a range of networking with other international tax consultants, and subscribe to international law journals and internet sites on international taxation, because tax law changes rapidly in different jurisdictions, and those changes can affect what you are structuring for your clients at the moment—or what you have structured in the past that might need adapting. Understanding that the world is becoming smaller in that
sense is increasingly important for tax attorneys, in Israel and elsewhere.
Shira Shine-Fried is a senior partner in Michael Shine, Tamir & Co., which she joined in 1999. She was admitted to the Israeli Bar, after completing her articles, in 1999. She studied law at the University of Manchester (UK).
Ms. Shine-Fried’s practice concentrates on multinational family asset structuring and planning, trust law, international trust administration, international tax and estate planning, corporate law, and inheritance law. She chairs the trust committee of the Israeli Bar Association, Tel-Aviv District. She is the author and co-author of many articles published in leading local and international law journals on the subjects of taxation of trusts in Israel, mergers and acquisitions, and inheritance. She is a member of STEP and the International Tax Planning Association.
I would like to dedicate this chapter to my father and mentor, who
founded our firm, Michael Shine.