Your Taxes: Israel upholds tax on transfer of real estate to trusts

This judgment was the final stop in a series of appeals, including an earlier hearing in the High Court of Justice.

House and calculator [Illustrative]. (photo credit: INGIMAGE)
House and calculator [Illustrative].
(photo credit: INGIMAGE)

In an important case for many olim families, Supreme Court President Esther Hayut has ruled that Israeli taxes are immediately levied on a transfer of Israeli real estate by a Canadian couple to a trust for the benefit of their Israeli resident daughter (Galis vs Tel Aviv 1 Land Appreciation Tax Director, January 3, 2023).

This judgment was the final stop in a series of appeals, including an earlier hearing in the High Court of Justice.

Many had been waiting to see if Israel could get its act together in such cases. The problem is there are two acts: the Income Tax Ordinance, which imposes capital-gains tax (CGT); and the Real Estate Taxation Law, which imposes land-appreciation tax (LAT) – a second capital-gains tax with different rules for taxing Israeli real-estate interests, especially when it comes to trusts.

Main facts of the Galis case

In the Galis case, a Canadian resident couple settled an irrevocable discretionary trust and transferred to it two Tel Aviv apartments for the benefit of their granddaughter, an Israeli resident. The granddaughter did not know about the trust or that she was a beneficiary.

The Income Tax Ordinance says no Israeli tax applies on a transfer of assets to an Israeli residents’ trust for the benefit of Israeli residents. But the Real Estate Taxation Law doesn’t say this.

Israel's High Court of Justice (credit: ISRAELTOURISM / WIKIMEDIA COMMONS)Israel's High Court of Justice (credit: ISRAELTOURISM / WIKIMEDIA COMMONS)

The taxpayer argued that Section 3 of the Real Estate Taxation Law exempts transfers of real-estate interests “to a trustee, guardian, liquidator or administrator pursuant to the Bankruptcy Ordinance” and certain other laws.

Hayut and the High Court ruled that Section 3 does not apply to trustees generally of “contractual trusts,” only trustees pursuant to the bankruptcy law and other laws listed in Section 3. In addition, they ruled that the Income Tax Ordinance exemption expressly does not apply to Israeli real estate.

Instead, the real-estate taxation law taxes a transfer of a right to Israeli real estate to anyone, including a trust and/or a trustee.

Hayut and the High Court agreed with the Israel Tax Authority’s Circular 3/2016 of August 9, 2016, which already pointed out the above.

Implications: The Canadian couple, as seller, must pay Israeli land-appreciation tax (25%-50%) on the Israeli property transfer to the trust, and the trust as purchaser must pay purchase tax of up to 10%.

If the trust later sells the property, another dollop of Israeli tax will be due.

But if the trust distributes the property to a beneficiary, exemption from Israeli double taxation is possible if timely notifications are filed within 30 days of each act.

Non-Israeli parties should also check the foreign tax situation.

Can Israeli tax be credited at each stage?

The US-Israel tax treaty and other tax treaties do not help much. So maximum care is needed to avoid double or triple taxation. Even quadruple taxation is possible if any party is in business and liable to VAT.

A possible solution and a ruling: Hayut cited what the ITA said: “There is nothing to stop taxpayers in future settling trusts defining specific designated beneficiaries whose identity is not open to change and who are aware ab initio that they are trust beneficiaries.” In other words, no more discretionary trusts, please.

The ITA recently issued a tax ruling in this vein. It explained that a trust need NOT exist, and all taxes may be avoided on the transfer of Israeli real estate to a trust if : (1) the transferor(s) are settlors and beneficiaries; (2) the transferor(s) retain material ownership of the apartments, even if ownership is registered in the name of the trustee; (3) if the trustee is serving merely as a “nominee/power of attorney holder”; (4) the trustee does what the couple want as beneficiaries and has no discretion.

This amounts to a nomineeship, or bare trust, rather than a full-fledged trust.

If the trustee later sells the real estate, it is the transferor(s) who must report and pay tax on that sale, or the heirs must if they sell inherited real estate.

What can go wrong? If additions and changes to the beneficiaries are allowed in the trust agreement, transfers in and out the trust are taxable per the ITA ruling.

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