Your Taxes: Effects of the 2013 budget proposals

New economic and fiscal policy will affect olim, trusts, gas investors and others.

By LEON HARRIS
April 30, 2013 21:47
An accountant [illustrative photo]

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

 
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The new Israeli government is changing its economic and fiscal policy.

Below are a few of the proposed changes that have been circulated for debate in the Economic Arrangements Bill.

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Immigrants: New disclosure rules

New residents and senior returning residents (who lived abroad 10 years) currently enjoy a 10-year exemption from Israeli tax on foreign-source income and gains (tax holiday).

Under the proposals, they will have to start reporting exempt income and gains derived abroad and to report overseas assets on any capital declaration they file regarding the tax-holiday period. This follows pressure from the OECD’s Global Forum on Transparency and Exchange of Information for Tax Purposes.

Currently, if a settlor moves to Israel and became an Israeli resident, the trust enjoys a 10-year exemption from Israeli tax (tax holiday) as the settlor on foreignsource income and gains. It is now proposed to stop the tax holiday for the trust if all the settlors die during the 10-year period.

New and senior returning resident investors in a controlled foreign corporation (CFC) can no longer be used to avoid a CFC tax liability or a foreign professional corporation (FPC) tax liability for other regular Israeli residents.



Trust tax changes

Restrictions are proposed regarding the Foreign Resident Settlor Trust (FRST). This currently refers to a trust where: (1) upon formation of the trust and in the tax year concerned, all the settlors (i.e., grantors) are foreign residents; or (2) in the tax concerned, all the settlors and beneficiaries are foreign residents.

For example, parents who have always resided outside Israel set up an FRST for the benefit of family in Israel. This can avoid all Israeli tax and reporting if the FRST derives all its income and gains outside Israel and distributes only cash to the family in Israel, not other assets.

Until now, it was thought that FRST trusts are good for the Israeli balance of payments, but the Israel Tax Authority (ITA) has other ideas.

Many changes are now proposed. In particular, if there is an Israeli resident beneficiary, the trustee will need to choose between paying ongoing Israeli tax at a rate of 25 percent on any trust allocation to the beneficiary or at a rate of 30% upon any distribution to the beneficiary.

The tax on distributions will not apply to the extent it is proven that trust capital deposited by the settlor is distributed.

Once a settlor of an FRST dies it is proposed to attribute trust income and assets to the beneficiaries. If any beneficiary is an Israeli resident, the trust will become a resident and taxable Israeli Residents’ Trust (IRT) and hold assets at their value as on the date of change (step up). Nevertheless, assets may also be allocated to foreign-resident beneficiaries – the implication being they may escape Israeli tax on their share of foreign income.

When all the settlors of an IRT die, the trust will be taxable in Israel unless all the beneficiaries are foreign residents, according to the proposals. Distributions to a beneficiary will be subject to capital-gains tax.

It is also proposed to require disclosure from beneficiaries of all trust distributions, including FRST distributions.

An FRST may also lose its tax privileged status if the settlor and beneficiary don’t have a close enough relationship. If a beneficiary is a “first degree” relative (parent, child or grandchild of the settlor), the FRST will be accepted as such if all other conditions are met. If a beneficiary is a “second degree” relative, there will be a rebuttable assumption that the trust is an FRST if all other conditions are met; this refers to spouse, brother, sister, parent, grandparent, issue, issue of spouse, spouse of the aforementioned, sibling’s issue, sibling of parent.

If there is no relationship between the settlor and beneficiary, the trust will be deemed to be a taxable IRT. The relationship must be disclosed to the ITA within 30 days after the trust is formed or within 60 days after the proposed law becomes effective.

Underlying companies owned by a trust

 It is proposed to require underlying companies to be owned 100% by the trustee and to register with the ITA within 30 days after incorporation. They will not be considered Israeli resident for tax-treaty purposes.

They may nevertheless be exempt from Israeli tax on foreign-source income and gains in certain circumstances.

Controlled foreign company

 Israeli residents are taxed on deemed dividends received from a controlled foreign company (CFC) if they hold 10% or more of the CFC. A foreign company (or any other body of persons) is considered to be a CFC if a series of conditions are met. In practice, a CFC will typically be an offshore passive holding company.

It is now proposed to tighten many of these conditions. In particular, the maximum tax rate on the CFC’s passive income would decline from 20% to 15% under the proposals. The minimum passive proportion of income or profits would decrease from 50% to 33.3%. The deemed foreign tax credit on deemed CFC dividends would no longer be allowed, only actual foreign tax credits on actual dividends or capital gains.

Foreign professional company

A foreign professional company (FPC) is deemed to be controlled and managed in Israel and, accordingly, taxable in Israel. A company is considered to be an FPC if a company meets all of the following conditions: (1) it has five or fewer individual shareholders; (2) it is owned 75% or more by Israeli residents; (3) most of its 10%-ormore shareholders conduct a special profession for the company; and (4) most of its income or profits are derived from a special profession.

The special professions include engineering, management, technical advice, financial advice, agency, law, medicine and many others.

The FPC rules are generally counteracted by Israel’s tax treaties. Therefore, it is proposed to tax the shareholders on deemed dividends from the FPC instead of taxing the FPC itself.

Foreign investors in gas companie
s

 It is proposed to impose Israeli capital-gains tax on foreign investors who sell Israeli securities of companies mainly invested in Israeli real-estate rights and rights to variable or fixed payments as consideration for the working of, or the right to work, mineral deposits, sources and other natural resources.

In other words, it seems the Israeli government wants to tax capital gains of foreign investors in Israeli gas companies now that large quantities of gas have been found in the Mediterranean Sea off Israel.

Reorganizations

Transactions involving moving assets into special-purpose vehicles so they can be securitized will now be allowed under Israel’s tax-free reorganization rules. Also, the reorganization rules will be applicable to partnerships, not only companies.

Overseas property sales

It is proposed to deny rollover relief when a depreciable property abroad is sold and the proceeds are reinvested in another property – known in the US as a 1031 exchange. For example, an Israeli investor who sells US real estate will need to pay US tax straight away to credit it against Israeli tax, which will no longer be capable of deferral by reinvesting the sale proceeds. This proposal, if adopted, will probably help foreign tax coffers more than the Israeli Treasury.

Reliance on professional opinions

 It is proposed that taxpayers will be required to disclose opinions and professional advice they have used or relied on from a professional adviser, including the resulting impact. This includes verbal advice about future transactions, and it will apply to all taxes including VAT and land-appreciation tax. Failure to disclose may lead to a fine of three times the tax saving, or NIS 50,000, whichever is higher.

Tax Authority guidance

 It is proposed that taxpayers should disclose in their tax return any position adopted that is contrary to published positions of the ITA. Failure to disclose may lead to a fine of 50%-100% of the tax saving. This could be difficult because the ITA is sometimes as creative as taxpayers.

The ITA claims this is accepted practice in the world.

Tax enforcement

Various measures are proposed to broaden tax enforcement. For example, the bailiffs will be allowed to seize taxpayers’ cars parked in a public area. Anyone guaranteeing the tax debts of a taxpayer may face the same fate if the taxpayer doesn’t pay his taxes.

Closing comments

The above proposals are not yet law. It remains to be seen what the Knesset will enact. For some reason, the biggest likely revenue raiser was overlooked: transfer pricing on the internal transactions of multinational groups. The changes regarding trusts appear to have political undertones, but they do not relate to all trusts.

If any of the above seems relevant to you, it is vital to obtain professional advice soon.

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

leon@hcat.co

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

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