As part of an amendment to the tax legislation in Israel (the Income Tax Ordinance (New Version), 1961 (“the Ordinance”)) which entered into effect on August 1, 2013 (“the Amendment”), and as a part of the battle being waged by the Israeli tax authorities against money laundering and tax planning, the relevant provisions of the Ordinance dealing with trusts were amended, inter alia, to effectively alter the tax reliefs previously granted to trusts involving new immigrants and returning residents (now termed in the Amendment as "eligible beneficiary" or "eligible resident").
Generally, new immigrants and returning residents are entitled to various tax reliefs for a period of 5 or 10 years from the date of their immigration (or return, as applicable) including, inter alia, an exemption on income tax with respect to active or passive income generated overseas (i.e., outside Israel), an exemption on capital gains tax with respect to gains deriving from the sale of capital assets located overseas and various other exemptions from reporting with respect to capital gains and ordinary income originating overseas.
As a consequence of the Amendment, the examination of the implementation of the relevant tax reliefs on trusts correspondingly changed from questioning the status and entitlement of the trust settlor to the relevant tax benefits to questioning the entitlement of the beneficiaries of the trust to such reliefs.
In this manner, and prior to the entry into effect of the Amendment, trusts that became 'Israeli resident trusts' due to the settlor's immigration to Israel, were not obliged to submit an annual report on income generated by the trust overseas or a capital statement for assets located outside of Israel during the tax relief period to which the settlor is entitled as a new immigrant. In other words, no Israeli tax or reporting duties can be imposed on the trust during the relevant tax relief period.
However, following the entry into effect of the Amendment, the said tax reliefs were reduced in a way that they will apply only in cases where all of the beneficiaries of the trust are considered as eligible beneficiaries or foreign (i.e., non-Israeli) residents. In addition, the tax reliefs in respect of the trust will apply for a period equal to the minimal balance of the tax relief period available to the eligible beneficiaries.
However, it was also determined that with respect to trusts that became 'Israeli resident trusts' following the settlor's immigration to Israel before enactment of the Amendment on August 1, 2013, the Amendment will not apply as long as the settlor of the trust is still alive. In such case, the trust will be accorded the treatment previously accorded to trusts of similar type in existence prior to enactment of the Amendment.
In this manner, in the event of the demise of the settlor of the trust, who, at the time of is death, was deemed an eligible resident, the trust will continue to attract the tax reliefs available to eligible residents only in cases where all of the beneficiaries of the trust are deemed to be eligible beneficiaries.
Moreover, the income of a foreign family trust which becomes a "relatives trust" (defined in the Amendment as an "Israeli resident beneficiary trust" wherein its foreign settlors and the Israeli residents beneficiaries are relatives) as a result of the immigration of one of the beneficiaries thereunder becoming an eligible beneficiary or the income of a "relatives trust", in which all of the beneficiaries are considered as eligible beneficiaries, will be able to enjoy the tax reliefs available to new immigrants. For example, a "relatives trust" which opted for the "distribution tax course" (which generally means that the trust distributions to an Israeli resident beneficiary originating from income generated overseas will be taxed at the rate of 30%) will be exempt from reporting on distributions that are made to eligible beneficiaries during the tax relief period applicable to such beneficiaries, and a "relatives trust" which opted for the "income tax course" (which generally means that the trust's income generated overseas which is attributable to an Israeli resident beneficiary will be taxed, regularly, at rate of 25%) will be exempt from reporting on income which was generated overseas and which reflects the relevant eligible beneficiary’s portion during the tax relief period applicable to him.
In the event of the demise of the settlor of a "relatives trust" resulting in the trust becoming an 'Israeli resident trust', the eligible beneficiaries thereunder will be able continue to enjoy the tax reliefs applicable to new immigrants during the tax relief period applicable to them.
It should be noted that with effect from the expiry of the tax relief period, the trust will be required to submit an annual report of the income generated by the trust outside of Israel as well as a capital statement regarding the trust assets located outside of Israel.
Therefore, we recommend examining the relevant trust status following the entry into effect of the Amendment with respect to each trust that is deemed a foreign settlor trust (or an Israeli beneficiary trust) or which comprises of new immigrants amongst its beneficiaries or settlors, and to ascertain whether the trust is indeed entitled to the tax and reporting reliefs outlined above.