Israeli Foreign Trusts

Below we have provided a summary of the Israeli trust structure

Residency

The key to understanding the taxability of trusts in Israel is to first define the tax residence of the settlor, where beneficiaries are Israeli residents, and, conversely, the tax residence of beneficiaries, where the settlor is an Israeli resident

The definition of “tax residence” can be explained by answer the question of “Where is the individual’s centre of life? If it can be shown that the centre of his life is in Israel,  notwithstanding the fact that he spends very little time physically residing in Israel, he will be an Israeli tax resident. If this test cannot be applied there is a minimum residence presumption test which takes into account the number of days a person is resident in Israel to decide if he is resident.

Revocable and Irrevocable Trusts

Israeli law also distinguishes between revocable and irrevocable trusts. A trust will be classified as either depending on the level of control the settlor preserves for himself over the management of the trusts assets upon establishment. In most cases a settlor will completely distance himself from asset management of a trust and transfers these powers to the trustee, this is referred to as an irrevocable trust.

The new trust law aims to regulate the taxation of irrevocable trusts and is expanded on below:

Within the framework of the Israeli Trust Law there are classified four types of trusts :

An Israeli Resident Trust (S75g)

A Foreign Resident Settlor Trust (S75i)

A Trust Pursuant to a Will (S75l)

A brief description of the different trust entities and the tax implications thereof is set out below; however for a full understand of trust taxation it is best to make reference to the Israeli Trust Law or contact our offices for further consultation :

Israeli Resident Trust

This is a trust in which, during the tax year the following criteria are met:

(1a). At the time of its creation at least one creator and at least one beneficiary were Israeli residents;

(1b). OR during the tax year at least one creator and at least one beneficiary thereof were Israeli residents;

A trust that is not a trust created by foreign residents and not a Foreign Resident Beneficiary Trust shall be deemed to be an Israeli Resident Trust.

The type cannot be a trust established by a will.

This type of trust can be either revocable or irrevocable.

Taxation:

In the case of an Israeli residents trust, the current income of the trustee (including capital gain) will be assessed as the income of an Israeli resident individual, e.g.: worldwide income in the trust will be taxable in Israel, subject to tax treaties.

Israeli tax rates are progressive for income from a business and are fixed for income such as interest (15%-20%), dividends (20%-25%) and capital gains (20%-25%) The trustee therefore pays tax on all taxable income and this removes the burden from beneficiaries from having to pay tax. In the case of an irrevocable trust, the trustee is able to distribute taxable income up to 6 months after year end and this income will be taxable in the hands of the beneficiary and thus it would be advantageous to do so if a beneficiary has special tax exemptions.

Foreign Resident Settlor Trust

This is a trust which, during the tax year, met at least one of the following conditions:

(2a). When the trust is established and throughout the tax year, all its settlors are foreign residents (regardless of the beneficiaries residency);

(2b). OR during the tax year, all its creators and all its beneficiaries are foreign residents.

This type of trust can be revocable or irrevocable.

Description:

Trust (2a) deals with cases where a foreign settlor for example, would like to establish a trust for an Israeli resident beneficiary.

Trust (2b) deals with cases where a foreign resident establishes a trust and the only connection he has to Israel is that it that the trust is managed by an Israeli trustee.

Taxation:

In the case of a foreign resident settlor trust and a foreign resident beneficiary trust, the current income of the trustee (including capital gain) will be assessed as income of a foreign resident individual. Income originating in Israel will be taxable, subject to Israel’s tax treaties. Income originating outside of Israel is not subject to taxation in Israel.

Regardless of whether this trust is irrevocable or not, a Foreign Resident Settler Trust is considered as a foreign individual resident for tax purposes. The assets held by the trustee will be viewed as assets held by a foreign individual resident and the trust’s income will be viewed as income of a foreign individual resident. So if the trust profits are not derived from sources in Israel, they are not taxable and there are no reporting obligations in Israel.

Not only is income from rental, interest, dividends, capital gains and business profits outside Israel not taxable in the trust and also not reportable by the Israeli trustee of the trust, but interest from within Israel in certain cases may also be exempt from taxation in the trust as it can be seen as interest income of a foreign resident.

Foreign Resident Beneficiary Trust

A trust in which, during the tax year provided that the following conditions are all met:

(3a). The trust is irrevocable;

(3b). All its beneficiaries are individual foreign-residents of known identity; an unborn beneficiary will be regarded as a beneficiary of known identity;

(3c). At least one of its creators is a resident of Israel;

(3d). If at the time the trust was established, the conditions A to C were true, then the following should also hold true;

(3d.1).   The trust documents explicitly provide than no Israeli resident beneficiary can be added;

(3d.2).   In order to maintain the trust’s status as a foreign-resident-beneficiary trust, the trustee must declare yearly that conditions (3a) + (3b) mentioned above are met. If the trustee fails to declare this, the trust will be classified as an Israeli Residents Trust and be taxed accordingly.

Description:

This trust is generally established by an Israeli settlor for the benefit of a foreign resident. In such a trust assets and income derived thereof are taken out of the Israeli tax network. There are however serious sanctions to ensure than the Israeli settlor indeed has no connection to his assets and the beneficiaries are indeed foreign residents as listed in (3d.1) and (3d.2).

Taxation:

A Foreign Resident Beneficiary Trust is considered a foreign resident and will be taxed in the same manner in which an individual foreign resident will be taxed. If the assets and income derived there of are from outside Israel, there is no taxation implications. If the assets and income derived there of are from within Israel, the double tax treaty, that would be applied as if the beneficiary had held the assets directly. The use of an Israeli trustee also has no effect on tax status of the trust.

A beneficiary, who immigrates to Israel during the tax year, would cause the trust to be classified as an Israeli Resident Trust and income from all sources would then become taxable, although the trust would enjoy the tax benefits given to new immigrants.

In the past settlors preferred appointing foreign trustees to oversee trusts established in Israel, due to the fact that having an Israeli trustee may have had an effect on the residency of the trust and thereby creating tax liabilities. However following changes in the tax law concerning trusts, the residency of the trustees no longer will effect a trusts tax position.