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This article is for you if you live in Israel and hope to receive/inherit assets one day from your family abroad, or if you are the potential donor/bequeather. The aim is not to change anyone's intentions, just to encourage you to check out the method with professional advisors in each country.
It is always wise to have a valid last will and testament which specifies how all the assets in your estate are to be distributed upon your eventual demise. Otherwise the assets will be distributed according to the rules of "intestacy" of the country(ies) concerned. This may not reflect your wishes, and it may take years and can cost plenty in legal and court fees to straighten things out. It is best to consult lawyers in each country when drawing up a will to check that it is well written and properly witnessed.
You may also consider taking out life insurance to help protect your family and dependents financially.
What about taxes? Taxes on estates and gifts can be a major issue because the entire capital amount is taxed, not only capital gains and income.
As a matter of public policy ("soak the rich"), many countries impose an estate tax or inheritance tax upon death as well as tax on lifetime gifts, subject to various rules and exemptions. These taxes can bite into the family wealth in a big way. For example, 47 percent federal tax in the United States (46% in 2006) plus state and local taxes in some cases; 40% in the UK; around 24% in Canada (capital gains tax) depending on the province; 20% in South Africa; and up to 60% in France - not to mention the annual French wealth tax of up to 1.8%, apparently.
What about Israel? It is wrong to say that Israel does not tax inheritances. It is true that Israel abolished its estate tax in 1981, however, Israel imposes capital gains tax on Israeli residents who sell inherited assets anywhere in the world, applying the cost basis of the last person that paid full consideration for those assets.
For example, Isaac lives in Israel and inherits in 2006 a house in the US from his late father Abraham that cost $100,000 back in 1966 and is now worth a million dollars. Let's suppose the US estate tax exemptions and lower rates of have already been used on other gifts and bequests. In such a case, the US federal estate tax may amount to $460,000 (46% of $1 million).
Isaac then decides to sell the house and cash in his million dollars. He will have 30 days to report and pay Israeli capital gains tax on the capital gain of $900,000 at rates ranging from 25% to 49%.
In other words, a combined tax burden of over 80% tax is easily possible in the two countries. Unfortunately, there is no provision in Israeli law or most tax treaties that expressly grants a credit for foreign estate/inheritance taxes against Israeli capital gains tax.
To add insult to injury, the capital gain will be calculated for Israeli tax purposes in new Israeli shekels and adjusted for inflation according to the Israeli consumer price index. Only the post 1993 inflationary gain is exempt - an additional 10% tax will be imposed on the pre-1994 inflationary gain!
This result is possible irrespective of where Abraham resided upon his demise if the house was in the US. A similar result is possible in the case of most assets (such as inherited or gifted stocks and shares) and in many countries - such as the UK, Canada, South Africa, or France.
All this leaves precious little for Issac to enjoy or to pass on to his son Jacob. As Queen Victoria reportedly said, "Up with this we shall not put."
So what action should be considered?
First, check out the tax rules and exemptions in the other country concerned.
Second, if Abraham were to sell his assets in his lifetime and give or bequeath cash to his son Isaac in Israel, there may still be foreign taxes to consider, but there would be no Israeli capital gains tax on the cash received or used by Isaac.
Third, if Abraham prefers to retain and not sell his assets, he may consider leaving them in a "testamentary trust" in his will for the benefit of Isaac (and his family) after his death.
Commencing January 1, 2006, a "Foreign Resident Settler Trust" formed entirely by non-Israeli residents may avoid Israeli tax on trust income and gains from assets/investments made outside Israel. Also, there would be no Israeli tax on distributions to Isaac, Jacob, et al. This is subject to various conditions in the Israeli tax law. In particular, no Israeli resident may have the ability to control or influence the conduct of the trust.
Therefore, appropriate advice should be obtained about the possibility of a testamentary trust in each country by each "multinational" family before it is too late?
Fourth, if all else fails, it might be possible to request some relief from double taxation from the Israeli tax authority, but no assurance at all can be given in this regard.
Finally, in the converse case of an Israeli resident donor, Israel will tax lifetime gifts of appreciated assets to a foreign resident, but there is no Israeli tax on cash gifts nor on assets bequeathed upon death.
The writer is an International Tax Partner at Ernst & Young Israel.