Taxation of Israeli Trusts

Taxation of Israeli Trusts

The background

Before we delve into the taxation of Israeli Trusts, it’s important to understand what a Trust is and why people create them. So, a trust is a legal relationship where property is held by one person for the benefit of another person. A trust is created by a “settlor” or “grantor” by transferring property to a “trustee”. The trustee then holds that property for the “beneficiaries”. And why do people establish trusts? They do so for various reasons. For example, the establishment of a trust may be the result of a desire to protect a property from creditors, of concern for the sick, the disabled and the incompetent, of concern for descendants, of tax planning and more.

A Trust will always have the following three parties:

  1. Grantor / Settlor – the person who directly or indirectly gave property to a Trustee.
  2. Trustee – a person who holds the assets of a Trust.
  3. Beneficiary – a person who is to enjoy, directly or indirectly, the Trust’s assets or income.
For example

Joseph owns a house which he wants to gift to his son. However, his son isn’t capable of looking after the house. So, Joseph turns to his good friend Sarah (who is loyal and trust worthy) and gives the house to her to hold for the benefit of his son. However, to make sure that his intentions will be carried out, Joseph writes a contract. The contract stipulates that Sarah is responsible to ensure that the property is well maintained and that she will hold the house for the benefit of Joseph’s son. Now Joseph has just created a Trust, with himself as the Settlor, Sarah as the Trustee, and his son as the beneficiary.

What is an Israeli Trust?

With effect of January 2014, the Israeli Tax Authority reformed the taxation laws of trusts in Israel. This reform effectively broadened the criteria of conditions required to deem a trust an Israeli tax-resident. In short, today almost all trusts which have at least one Israeli tax-resident beneficiary, is taxable in Israel. However, there are exceptions, for example Trusts of an Oleh Chadash (first time tax residents) or returning residents, provided the necessary conditions are met.

Taxation of Israeli Trusts?

There are five categories of Trusts defined in Israeli tax law. Once a trust has been correctly categorized, the relevant taxation treatment can then be applied. What are the different types of Israeli trusts?

  1. Non-resident trust
  2. Non-resident beneficiary trust
  3. Israeli trust
  4. Israeli-resident beneficiary trust
  5. Trust by will

Non-Resident Trust (נאמנות תושבי חוץ)

A non-resident Trust meets all of the following criteria:

  1. The Settlors are foreign tax residents.
  2. All of the beneficiaries are either Organizations for the Public, or foreign tax-residents.
  3. The trust has never had an Israeli tax resident beneficiary since its creation.

Tax Treatment

This Trust will be exempt from paying tax on income generated outside of Israel. However, incomes generated within Israel will still be taxable.

This type of trust will maintain its status upon the settlor’s death, provided the settlor is considered a foreign tax-resident at the time of their death, and the beneficiaries continue being foreign tax-residents.

Non-resident Beneficiary Trusts (נאמנות נהנה תושב חוץ)

A Non-resident Beneficiary Trust is a Trust which meets all the following conditions:

  1. At least one of the settlors, is a tax-resident of Israel.
  2. All beneficiaries are foreign tax-residents, and their identities are known.
  3. The Trust is irrevocable (as per the definition of the Israeli Tax Ordinance)
  4. The Trust specifically excludes Israeli tax-resident beneficiaries.

Tax Treatment

This trust will be exempt from paying tax on income generated outside the borders of Israel. However, incomes generated within Israel will be taxable. The trustee of a non-resident beneficiary trust must submit an annual report to the Israeli Tax Authority.

The trust will maintain its status after the death of the settlors, provided that all the beneficiaries continue being foreign tax-residents.

Israeli Resident Trust (נאמנות תושבי ישראל)

An Israeli Resident Trust is a Trust which meets all the following conditions:

  1. At the time of the creation of the Trust, at least one Settlor and one beneficiary were considered tax-residents of Israel.
  2. In the current tax year at least one settlor and one beneficiary are tax-residents of Israel.

Tax Treatment

In this Trust, the worldwide income of the Trust will be subject to Israeli taxation at the normal tax rates for trusts (see below). Once tax has been paid on the trust level, distributions to the beneficiaries are not subject to tax.

Israeli Resident Beneficiary Trust (נאמנות נהנה תושב ישראל)

An Israeli Resident Beneficiary Trust is a trust which has at least one Israeli tax-resident beneficiary and all the settlors are foreign tax residents (and have been so since they created the Trust). This type of trust has two subcategories. 

Regular Israeli Resident Beneficiary Trust

This type of trust does not have a close relationship between all its settlors and beneficiaries.

Tax Treatment

In this Trust, the worldwide income of the Trust will be subject to Israeli taxation at the normal tax rates for trusts (see below). Once tax has been paid on the trust level, distributions to the beneficiaries are not subject to tax.

Close Relatives Trust

This type of trust has a close relationship between all its settlors and all the beneficiaries of Israeli residents included in it, in one of the following two ways:

The settlor of the Trust is the child, grandchild, spouse or parent of the beneficiary.

Tax Treatment

25% Tax on Income

The proportion of incomes intended for distribution to an Israeli tax-residnt beneficiary will be taxed in the current year at a flat rate of tax of 25%. In such a scenario, the income on which tax has been paid, shall be exempt from tax at the date of actual distribution.

To be eligible for this tax route, the Trustee must submit an election to the Tax Authority. If the trustee has elected the 25% tax route, they will not be able to change their decision in future years.

30% Tax on Distributions

The income of the Trust would not be subject to tax in the year in which the income accrued. However, distributions to an Israeli resident beneficiary will be taxed at a rate of 30%. Distributions out of capital will be tax exempt if the trustee can prove so.

Trust by Will (נאמנות לפי צוואה)

A trust which was created following a provision in a will and whose creators are mitzvot who at the time of their death were considered residents of Israel. In a trust of this type, the income of the trustee will be considered as the income of the beneficiary and the assets of the trustee will be considered as the assets of the beneficiary.

Tax Treatment

In this Trust, the worldwide income of the Trust will be subject to Israeli taxation at the normal tax rates for trusts (see below). Once tax has been paid on the trust level, distributions to the beneficiaries are not subject to tax.

Tax Rates on Israeli Trusts?

If the income of a Trust is taxable in Israel, the tax rates are usually the same as that for an individual. However, a Trust is not eligible to benefit from the lower rates of tax of the marginal tax brackets. So, if income is taxed at the marginal tax rates, the tax rate would be the highest rate of tax, starting from the first shekel (2021 – 48%). There are various incomes which have special rates of tax (mostly between 10% – 30%), such as dividends, interest, rents, capital gains etc. In fact, most passive incomes can be taxed using special tax rates.

Read more about tax rates for individuals here.

Allocating Israeli Trust Income to be taxed on the Settlor or Beneficiary.

In some specific scenarios, the Trustee can elect to transfer the income of the Trust to either the settlor or beneficiary to be taxed as their personal income. However, the Trustees must ensure that the Trust stands by the relevant requirements and that the correct notices are submitted on time.

Trust Asset Holding Companies

Many Trustees prefer to hold assets of a trust via a Trust Asset Holding Company. This allows for a separation between their personal assets and those of the trust. The Israeli Tax Authority will treat a Trust Asset Holding Company as see-through for Israeli Tax Purposes. The company must meet the following conditions:

  1. Be incorporated solely for the purpose of holding the trust assets.
  2. All the shares must be held by the Trustee.
  3. The appropriate notice was submitted to the Israeli Tax Authority within 90-days of incorporation. The notice of Form 153 can be downloaded from the Israeli Tax Authorities website here.

Does Appointing an Israeli Trustee make the Trust taxable in Israel?

Generally, the appointment of an Israeli trustee in itself does not impact the tax residency of the trust. However, it should be noted that if the trust holds shares of a foreign company and by appointing an Israeli trustee the control and management of that company will be carried out from Israel, this may deem the company to be an Israeli tax resident and therefore taxable in Israel.

Late reporting for Israeli Trusts?

Trusts which were established prior to 2014, may have been deemed Israeli tax residents since 2006. The tax treatment of these Trusts can be complex and often require dialogue with the Tax Authority to clarify a tax position. In any event, if a Trustee has only recently become aware of a requirement to report in Israel, it is advised to take professional advice prior to proceeding. Late filing penalties for Israeli Trusts can be appealed if there is a justified reason for the late filing.

Summary

In summary, if a trust has an Israeli tax-resident beneficiary, it is most likely subject to Israeli taxation. The income tax rates, will be subject to Israeli taxation at a rate of tax determined by the source of income. Income taxed at the marginal tax rates will be taxed at the highest rate (2021 – 48%). Professional advice and consultancy should be taken in the event of establishing the trust and the ongoing management to ensure that tax efficiency is maintained.

The Israeli Tax Authority also provide various forms and information in English on their official website here.

The above should not be construed as a recommendation and / or opinion. It is recommended to obtain personalized professional advice. We will be happy to be at your disposal for any questions and / or clarifications in this matter and in general.

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