Taxation and tax planning for trusts
Trusts are a legal relationship created by an agreement whereby an asset owner (the settlor) transfers assets he owns to another person (the trustee), with the intention that the latter manages them for the benefit of a third party (the beneficiary).
Until Amendment 132, which essentially created the field of international taxation in Israel, trusts were not part of the Israeli tax base. In 2006, with Amendment 147 to the Income Tax Ordinance, trusts were first introduced into Israeli tax law. Amendment 147 effectively established the tax liability applicable to trusts. The tax liability of a trust is determined according to the residency of the settlor.
As part of Amendment 147, four types of trusts were defined as follows:
- Israeli Resident Trust (Section 75Z of the Ordinance)
- Settlor Foreign Resident Trust (Section 75T of the Ordinance as amended by Amendment 197)
- Beneficiary Foreign Resident Trust (Section 75Y of the Ordinance)
- Testamentary Trust (Section 75YB of the Ordinance)
In 2013, another significant amendment, Amendment 197 to the Income Tax Ordinance, was made, which changed the rules of the game in the taxation of trusts. This amendment ranged from changing the definitions to expanding the tax base to include trusts that were not previously covered.
As part of Amendment 197, the status of a foreign settlor trust was abolished, and instead, the following types of trusts were defined:
- A beneficiary Israeli resident trust that is not a relative trust (Section 75H1(a) of the Ordinance)
- A beneficiary Israeli resident trust that is a relative trust (Section 75H1(b) of the Ordinance)
- A foreign resident trust (Section 75T of the Ordinance as amended by Amendment 197).
The tax liability and classification of a trust depend on the identity and residency of the settlor and the identity of the beneficiary in each trust. A change in the residency status of either can trigger a tax event. The section on trusts in the Income Tax Ordinance and the legal amendments concerning trusts are comprehensive, substantial, and particularly complex.
The amendments made include changes in including certain types of trusts in the tax base and proposing different arrangements for each type of trust. These amendments require a thorough analysis of each case on its own merits to optimize the outcome, as well as an accurate classification of the settlors and beneficiaries of the trust according to the definitions in the law.
Transition between different types of trusts
As mentioned, trusts under the Income Tax Ordinance are divided into six different types. These types are grouped according to the residency of the settlor and the beneficiary. Changes in the residency of either the settlor or the beneficiary will affect the type of trust and may trigger a tax event within the trust.
For example, in an Israeli resident trust, if the beneficiary moves their residency outside of Israel, this will trigger a tax event – a severance of the trust’s residency. Section 100A of the Ordinance must be applied, and tax must be paid on the trust’s assets. In another case, if the settlor of the trust immigrates to Israel, the trust may be eligible for new immigrant benefits.
Acquisition and distribution from a trust:
Acquisition for a trust – the introduction of an asset by the settlor into the trust.
Distribution in a trust – the division of the trust’s assets among the beneficiaries.
Based on the types of trusts detailed above, it can be determined whether the acquisition and distribution from the trust constitute a taxable or exempt tax event. The principle of trust taxation is based on the continuity of taxation. To determine whether the distribution/acquisition constitutes a taxable event in a specific trust, it is necessary to map the trust and its history. This involves mapping the tax sequence and examining the legal provisions in various situations.
Exemptions, deductions, and personal exemptions in trust taxation
Trust taxation is very reminiscent of individual taxation but is not identical to it. Trusts are not eligible for the individual’s credit points nor do they benefit from a disability exemption for their tax liability. Moreover, marginal tax rates are not tiered, and business activity in trusts is taxed at the highest rate.
There are certain situations in which it is possible to request from the tax authority to include the trust’s income/loss in the settlor’s/beneficiary’s tax file, subject to conditions. This means that the entire income (or loss) is attributed to the individual and taxed according to the rules applicable to them. Our office has extensive experience in the field of trusts, including establishment, regulation, and ongoing management.
Our firm specializes in negotiating with the tax authority to arrange various trusts.
