One of the quirks of Israeli tax law is that real estate gains are taxed and administered separately from other capital gains. Never the twain shall meet (well, hardly ever).
The Supreme Court has just issued a final judgement confirming that a contribution of Israeli real estate into a trust is a taxable event resulting in land appreciation tax (up to 33% generally) for the settlor (someone who makes a settlement or creates a trust of property) and purchase tax (up to 10% generally) for the trust (Galis vs Tel-Aviv 1 Real Estate Assessing Officer, Civil Appeal 7610/19). All this on what may seem like a purely paper transaction. Immigrant families and others should watch out.
Main facts of the case
A Canadian resident couple established an irrevocable trust and transferred to it to Israeli real estate for the benefit of their granddaughter, an Israeli resident beneficiary. The real estate consisted of two apartments in Tel-Aviv, one in Ashdod and one in Beit Shemesh. The granddaughter was not aware of the trust or that she was a beneficiary.
The trust documents provided that the Canadian settlors did not control the trust assets. Instead, an Israeli trustee was empowered to administer the trust assets and to take any measures required during the term of the trust including distribution of profits to the beneficiaries. The settlors retained a degree of influence by means of a non-binding letter of wishes and the appointment of a protector who could make changes regarding the trustees and beneficiary(ies).
The taxpayer (settlors) argued that the income tax ordinance exempted the contribution of assets, including real estate, into a trust in such cases. The Israel Tax Authority argued that the provisions of the Israeli Real Estate Tax Law (RETL) resulted in tax.
The Supreme Court ruled that the ITO exemption only applied to capital gains taxed under Part E of the ITO, which expressly excludes Israeli real estate assets (ITO Section 75 Zayin (Vav) and Section 88 definition of “aAsset”).
Pursuant to the RETL, a transfer of a right to Israeli real estate to anyone, including a trust and/or a trustee, is a taxable “sale” (RETL Section 1) resulting in liabilities to land appreciation tax and purchase tax.
So, if a contribution of Israeli real estate to a trust is taxed straight away, what happens if the trust later sells the property concerned? The Supreme Court pointed out that exemption from Israeli double taxation is possible upon a distribution of Israeli real estate by a trustee to a beneficiary, if timely notifications are filed within 30 days of each act (RETL Secs 69 and 73). Other exemptions might also apply under the RETL, but not for transfers to a trustee, guardian, liquidator or receiver under certain legislation (RETL Sec. 3), as tax legislation is not included.
In short, the court based its ruling on an analysis that the ITO does not cover transfers of Israeli real estate that is subject to the provisions of the RETL.
Moreover, the court said it was not possible to argue there was no exemption for an incomplete “sale” because of the role of the protector or because the beneficiary was unaware she was a beneficiary. This was mainly because the trust was irrevocable.
Unfortunately, the taxpayer lost and must pay sale and purchase taxes on the contribution of Israeli real estate to the trust. If the trust later sells the Israeli real estate, another dollop of tax may be due. Non-Israeli parties should also check the foreign tax situation. Can Israeli tax be credited at each stage?
The outcome might be different if a trust buys Israel real estate and/or distributes it, depending on the circumstances.
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 of the parties are in business and liable for VAT.
As always, consult experienced legal and tax advisers in each country at an early stage in specific cases. Oren Biran, Adv. is partner and head of the tax department at Gross GKH Law Firm. Leon Harris is a certified public accountant at Harris Horoviz Consulting & Tax Ltd. [email protected], [email protected]