Michael Shine & Partners
Use of Trust or Other Similar Vehicle to Assist in Personal Tax Planning for Wealth
Due to the fact that the State of Israel was only established in 1948 and inheritance tax was abolished in 1981, trusts were not widely used by Israelis for personal tax planning.
However, with the influx of new immigrants (already familiar with trusts), the dramatic increase in Israeli High Net Worth (HNW) families, and the constant threat of a reintroduction of IHT, Israelis are now turning to trusts for effective asset protection and estate planning.
It is possible to form an “Israeli law” trust and indeed there is Israeli trust legislation – the Trust Law 5739-1979 – governing powers, duties, rights and conduct of trustees.
However Israeli trusts are usually deferred in favour of foreign law trusts, which are significantly more appealing to Israeli resident and domiciled High Net Worth families for a number of key reasons. Section 8 of the Succession Law 5725-1965 states that if one were to create a trust under Israeli law, the trust would become void on the settlor’s death and revert to the settlor’s estate and the trust assets would pass to the settlor’s heirs in accordance with his Will or the laws of intestacy, as the case may be.
This law undermines one of the fundamental principles of a trust, being that once the settlor transfers property to his trustees to hold the same upon trust, the settlor is no longer viewed as the owner of the property.
The difficulty caused by the Succession Law gives significant importance to the use of foreign trusts in Israel, since foreign trusts are not governed by Israeli law and will, therefore, not revert to the settlor’s estate. This coupled with the Trust Law 5739-1979, which is somewhat primitive and weak, contributes to make Israel an unattractive jurisdiction of proper law for a trust and means that foreign trusts are more likely to be utilised.
Trusts, Foundations and other similar vehicles can be treated in diametrically opposed ways for Israeli tax purposes depending on the tax statuses of the settlor and beneficiaries.
In 2014, Amendment 197 to the Income Tax Ordinance-New Version 5721-1961 (2005) (“Amendment 197“) came into effect which gives the Israel Tax Authority (the “ITA“) the right to tax all trusts (worldwide) which fall within the parameters of the legislation. In contrast to most other jurisdictions, Israel classifies the trust as the liable taxpayer and not the individual beneficiaries.
All trusts with a foreign settlor and at least one Israeli beneficiary, even where the trust is fully discretionary and there is a class of unspecified beneficiaries (but which includes at least one Israeli) – are subject to reporting requirements and tax in Israel.
There is however a favourable exemption applicable to qualifying new Israeli immigrants (“New Immigrant“) and veteran returning residents (“Returning Residents“), based on meeting certain requirements, and this is discussed further below.
In accordance with Amendment 197, the tax applicable to the trust will vary according to the status of the settlor(s) and beneficiaries. Amendment 197 classifies trusts according to the following categories:
Israeli Resident Trust (A)
- Deceased foreign Settlor
- At least one Israeli resident beneficiary (excepting New Immigrants/Returning Residents)
- Subject to tax on annual worldwide income of trust
Israeli Resident Trust (B)
- Israeli settlor
- At least one Israeli beneficiary (excepting New Immigrants/Returning Residents)
- Subject to tax on worldwide income of trust
- Living foreign Settlor or if foreign Settlor died after 1/1/2014 but his spouse is still alive
- Israeli beneficiary
- Israeli beneficiaries are close relatives
- Trustee can make a one-time irrevocable election for annual trust income allocated to Israeli beneficiary’s share to be taxed or rather distributions to Israeli beneficiary to be taxed
- Following demise of foreign Settlor and his/her spouse, trust will automatically become an Israeli Resident Trust
Foreign Resident Trust
- All settlors and beneficiaries are foreign residents
- Can be revocable or irrevocable
- Only Israeli sourced income is subject to tax and reporting in Israel
As mentioned above, there is a limited exemption applicable to New Immigrants and Returning Residents. If it is determined that the New Immigrant or Returning Resident is entitled to the 10 year tax exemption granted by law (see Emigrating to Israel Section), then the trust may remain exempt from tax and reporting during the tax exemption period, as applicable.
Such a Trust would be classified as an Israeli Resident Trust but shall be exempt from tax and reporting in accordance with the following scenario:
Israeli Resident Trust (C)
- Foreign Settlor/ New Immigrant or Returning Resident Settlor
- New Immigrant/Returning Resident Beneficiary (entitled to tax exemption)
- No ordinary Israeli beneficiaries without tax exemption
- No tax or reporting for duration of Beneficiary’s tax exemption
In accordance with Amendment 197, if there is a trust with Israeli beneficiaries (without any entitlement to tax exemption) and the trust assets are held by an intervening holding company, it is crucial for the trust to own 100% of the intervening holding company and report to the Israeli Tax Authority within 90 days of establishment. This ensures that the holding company is considered transparent and pierced through for tax purposes and is not considered a Controlled Foreign Corporation (CFC), which would have detrimental tax implications.
A trust established by an Israeli resident settlor exclusively for the benefit of non-Israeli beneficiaries is reportable in Israel but is not subject to any tax in Israel, so long as it is irrevocable (according to the applicable legal definition) and there is no Israeli sourced income/gains. This is a useful tax planning tool for Israelis with non-resident children or grandchildren, who can benefit from a long-term tax-free growth in those assets for their eventual benefit.
Testamentary trusts established by Will, shall also fall within the parameters of Amendment 197, although since such a trust is only established on death, the application of Amendment 197 shall only crystallise on death.