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Your Taxes: New tax regime for trusts in 2014

December 24, 2013 22:44

"Israel looks set to turn away $2 billion a year, and a number of people may be needlessly excluded from family trusts."

An accountant [illustrative photo]

An accountant calculator taxes 370. (photo credit:Ivan Alvarado / Reuters)

Israel looks set to turn away $2 billion a year, and a number of people may be needlessly excluded from family trusts.

What is going on? A trust is an arrangement in which, the settlor (grantor) contributes assets to a trustee to administer for the benefit of beneficiaries, who are usually wives, children, grandchildren, etc.

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Trusts are big business. Each year around $3b. flows into the Israeli economy from family relatives abroad. A good part flows via family trusts. Now all that is about to change.

The history: Until the end of 2005, Israel only taxed trusts if they were revocable or in favor of children under 20.

Commencing in 2006, Israel adopted a comprehensive new tax regime for trusts, based on New Zealand tax law.

In the years 2006-13, trusts settled by foreign residents in favor of Israeli resident beneficiaries were usually outside the Israeli tax net, unless the beneficiaries exercised “control or influence” over the trust.

Commencing January 1, 2014, Israel will start taxing any trust anywhere in the world that has an Israeli resident beneficiary.

The new rules: Under the new 2014 rules, if the settlor or his/her spouse are still alive and related to the beneficiary (a “relatives’ trust”), Israel will start imposing tax at a rate of 30 percent of income distributed to beneficiaries.

Alternatively, it will be possible to elect 25% on annual trust income, regardless of distributions.

Existing family trusts must be reported by January 27, 2014. The 25% tax rate, if desired, must be elected by the same date. So time is of the essence.

However, if the settlor and his/her spouse are both deceased, the trust becomes an “Israeli residents’ trust” and will need to pay Israeli tax at rates of 30%-52% of annual trust income, regardless of distributions.

The onus is on the trustee to report and pay the tax, notwithstanding any foreign law. The Israel Tax Authority can also enforce unpaid tax debts against the beneficiaries.

How will the ITA know? Beneficiaries must report trust distributions received since August 1, 2013. Before then they only had to report distributions in kind, not cash.

Reports will also flow into the ITA from with an Israeli tax file – usually people with businesses or overseas investments.

They must periodically file “capital declarations” (hatsarat hon) listing their worldwide assets.

An exception applies to new and senior returning residents (who lived abroad 10 years) who arrived after 2006 and enjoy a 10-year Israeli tax holiday regarding overseas income, gains and asset reporting.

That’s it in a nutshell. If you are potentially affected, please get Israeli professional advice as soon as possible on how to prepare.

Experience already suggests the new 2014 rules will stir up a hornet’s nest of messy issues.

Hot issues: What are the anticipated hot issues for trusts?

First, simply excluding Israeli residents from being beneficiaries may be the wrong solution. The new 2014 rules impose Israeli tax on trusts that ever had Israeli resident beneficiaries since their inception. If your trustee wants to exclude you, get a second opinion fast.

Second, if a trust has Israeli and foreign resident beneficiaries, the entire trust may get swept into the Israeli tax net. On September 1, 2013, the ITA announced it was preparing new rules to deal with the issue, but nothing has yet happened.

There are old regulations that address the subject, but they are full of conditions that are difficult to meet.

Third, if a trust sells assets in 2014 that appreciated in value over many years, the entire capital gain will get swept into the Israeli tax net. On September 1, 2013, the ITA announced it was preparing new rules to deal with the issue, but nothing has yet happened.

Fourth, it is very hard to prove that Israeli resident beneficiaries do not exercise any control or influence; it means proving a nothing. Trustees are under a general duty to consider the best interests of the beneficiaries. But how can they do so without speaking to the beneficiaries? In practice, trust deeds need careful review. A draft new ruling procedure is expected soon to address control or influence situations.

Fifth, the foreign tax-credit rules in Israel are unclear in the trust context. On September 1, 2013, the ITA announced it was preparing new rules to deal with the issue, but nothing has yet happened.

What action should trustees be considering? A new trust may sometimes be worth considering. But it must be structured properly, as certain types of reorganization are not allowed under the tax law.

Some trustees are looking to generate capital gains while they are exempt under the pre-2014 rules. Any subsequent reinvestment would be at current market prices. This will be helpful upon any future trust sale.

Also, if the settlor or beneficiaries are new residents, or senior returning residents after living abroad 10 years, they enjoy a 10-year exemption from Israeli tax on overseas income or gains. And the trust may enjoy a matching 10-year exemption under the 2014 rules if certain conditions are met. But check the foreign tax position as well.

Various other possible courses of action also exist, and specialist advice is needed. Or else wait and see if the ITA will announce a new tax ruling procedure for trusts; one is reported to be in the offing.

As always, consult experienced tax advisers in each country at an early stage in specific cases.

Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.

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