A trust is conceptually different from a company (corporation), as a company is generally a separate person for legal purposes in most countries. The Trust Law, 1979, in Israel recognizes a trust and defines it as a relationship whereby a trustee is bound to hold trust property and to act in respect thereto in the interest of a beneficiary or for some other purpose. This definition is similar to that found in the "common law" of most Anglo-Saxon countries.
The parties to a trust are usually:
â€¢ The settlor (also known as the grantor in the US), who contributes assets to a trust
â€¢ The trustee, who formally owns the trust property but for the benefit of the beneficiaries
â€¢ The beneficiary or beneficiaries, who ultimately will receive income and/or assets from the trust
â€¢ The protector (also known as the appointor in some countries) - found in some trusts only. The protector typically vets important decisions of the trustee and has powers to replace the trustee.
A comprehensive new trust tax regime was effective in Israel commencing January 1, 2006. It applies to common law trusts and civil law foundations among others. We have discussed the new Israeli tax regime in the past. Following is a brief recap.
The aim of the new regime is to prevent tax avoidance by Israeli resident settlors of an Israeli Residents' Trust by attributing annual worldwide trust income and gains to the settlor or the beneficiaries and requiring the trustee to report and pay the Israeli tax on their behalf. This will apply irrespective of where the trustee is located.
In the case of a Foreign Resident Settlor Trust formed entirely by non-resident settlors, an exemption may apply to trust income
and gains. Originally, this was meant to encourage inward flows of capital from families abroad to relatives in Israel. However, the exemption is conditional on the Israeli resident beneficiaries having no ability to control or influence the conduct of the trust. In practice, this may be difficult to prove and various other conditions must also be met.
A separate exemption may also apply to income and gains of an irrevocable Foreign Resident Beneficiary Trust formed by an Israeli settlor exclusively for foreign resident beneficiaries, provided various conditions are met.
In the case of a Testamentary Trust formed under the will of a person who was Israeli resident upon his death, the Israeli tax outcome will depend on the tax status of each beneficiary.
Detailed rules govern migrations, the contribution of assets to each type of trust and the distribution of income and assets from them. In addition, reporting and enforcement provisions are prescribed regarding trustees, settlors and beneficiaries, irrespective of their location, as well. In particular, unpaid final (non-appealable) tax debts may be collected from the settlor(s) and/or from the beneficiaries up to the amounts distributed to them (which could potentially mean up to 100% taxation).
With regard to annual reporting of trust details to the Israeli tax authority, the requirements may be briefly summarized as follows:
Tax returns for the years 2003 - 2005:
â€¢ From the Trustee: No requirement
â€¢ From the settlor: Details of any trust settled in the year (starting 2002)
â€¢ From a beneficiary: Trust details - if a person received NIS 100,000 from trust monies in the year, or is a beneficiary of the trust
Tax returns for 2006 and later:
â€¢ From the Trustee: Trust income and other details are reportable and tax payable thereon by the trustee.
â€¢ From the settlor: Details of any trust settled or contributed in the year
â€¢ From a beneficiary: If he or she received a distribution in the year, details of the distribution and the trust
Transitional reporting requirements are expected to apply in 2006 and 2007 and other transitional rules exist.
In the US, there are detailed tax rules aimed at preventing tax planning using trusts. US persons and anyone else who holds US assets should consult US tax and legal advisors in specific cases. Following is a brief summary of certain aspects of the US tax rules for trusts.
Trusts (and estates) are generally treated for US tax purposes as separate taxpayers and, with some important qualifications, are taxed similarly to individuals. A "simple trust" is one that is required to distribute all its income to beneficiaries each year; cannot make charitable contributions; and generally makes no distribution of trust "corpus" (capital) during the year. Other trusts are generally "complex trusts," which permit accumulation of income and/or charitable contributions or distributions of principal. A trust may switch from simple to complex and vice versa.
Charitable deductions for US tax purposes are available for amounts donated to recognized US charities out of gross income, but not out of trust corpus, of complex trusts. A deduction available for distributions to beneficiaries is determined by reference to Distributable Net Income - the maximum deduction for distributions and the maximum amount that beneficiaries will have to report as income even if the income is not distributed in the tax year.
Beneficiaries of "complex trusts" are taxed in two tiers in the US. The first tier consists of income required to be distributed (up to DNI) and includes distributions that can be paid out of income or corpus, to the extent paid out of income, without charitable deductions. The second tier includes all other distributions actually paid or required to be paid with charitable deductions.
"Grantor trusts" are trusts over which the grantor (settlor) or grantor's spouse retain a certain level of control or a current or certain reversionary interest in income or corpus of the trust. The income from a Grantor Trust is taxed to the grantor, not the trust nor the beneficiaries. If a US person makes a transfer to a "foreign trust" with a US beneficiary, the income of the trust will be taxed to the transferor, unless the transfer is by reason of death (but an estate tax liability may need to be considered); for fair market value; or to a foreign employee benefit or charitable trust.
"Throwback rules" generally tax US beneficiaries of "foreign complex trusts" on distributions of income accumulated by the trust in prior years as if the income had been distributed in the years received by the trust. The compound interest charge on such back tax can sometimes be large.
As for the UK, dramatically new tax rules are still emerging in 2006.
To sum up, the Israeli tax rules for trusts are very different from those of other countries such as the US or the UK. In the case of a multinational family, care is needed to avoid double taxation - it is not enough for a trust to be irrevocable to escape tax altogether. Professional advisors should be consulted in each country.
The writer is an International Tax Partner at Ernst & Young Israel.
(With thanks to Ed Rieu of the Ernst & Young U.S. Desk, London)a