(photo credit: INGIMAGE)
It is common knowledge that new immigrants enjoy a 10-year exemption from taxes and reporting, after which they are required to start paying taxes on foreign income. But very few know that the end of the 10-year exemption can also have serious implications for their family trusts.
During the 10-year exemption the tax benefits for the new immigrant extends also to any trust in which he is a settlor or beneficiary (assuming there are no other Israeli resident settlors or beneficiaries). However, as soon as the 10-year benefit period for the beneficiary lapses, the trust is also subject to tax in Israel.
Under Israeli tax law, trusts that have even a single Israeli settlor or beneficiary are generally subject to tax in Israel on all their worldwide income. Not only that, the letter of the law even implies that having an Israeli resident settlor or beneficiary at any point in time will cause the trust to become an Israeli taxpayer for all intents and purposes.
Individuals that made aliyah in 2009, for example, will find out that as of 2019 their family trust may need to start paying taxes in Israel and file tax returns, even with respect to the portion allocable to non-Israeli beneficiaries. This is in addition to their personal obligation to file tax returns in Israel because of their being beneficiaries in a trust.
However, this fate can be prevented with tax planning and making necessary changes to the trust structure.
For example, bifurcating the trust into several sub-trusts and decanting part of the assets into a new “Israeli trust” will help protect the foreign beneficiaries from unnecessary taxes and reporting obligations in Israel.
But separating Israeli taxpayers from foreign taxpayers or new immigrants is not always enough. The trust deed should also be worded carefully to prevent any “tax accidents” that will create unexpected tax liabilities. A common tax accident usually occurs, surprisingly enough, when a new child is born.
Since Israeli law extends the 10-year new immigrant benefits only to trusts that have no Israeli resident beneficiaries (other than new immigrants), a trust for the benefit of descendants of the settlor could create a real problem when a new descendant is an Israeli resident. Even a one-day old could potentially be considered an Israeli beneficiary for this purpose.
Another common problem that comes up frequently is trusts that have mistimed distributions. Some types of trusts are subject to tax in Israel upon distribution. Oddly enough, with respect to this type of trusts, a distribution to a new immigrant after the 10-year period is over is subject to tax at a 33% rate, without accounting for the fact that the income distributed was generated during the 10 years.
Adding to this problem, these trusts sometimes have issues utilizing foreign tax credits to offset their Israeli taxes, which may result in effective double taxation if the distribution is not timed correctly. In order to mitigate this risk, it is recommended to make any required distributions prior to the end of the 10 years or to distribute the assets to a new trust that is not taxable upon distributions.The writer is a lawyer and Israeli accountant who specializes in Israeli taxation, international taxation and the taxation of domestic and international trusts at the Benjamini & Co. Law firm.