Your taxes: Death defying taxes

The budget intends to introduce a back-door estate tax for trusts commonly found in families with its members living in Israel and elsewhere.

Dollar bills 370 (photo credit: Steve Marcus / Reuters)
Dollar bills 370
(photo credit: Steve Marcus / Reuters)
In 1981 Israel abolished its estate tax because it failed to collect adequate taxes and was costing too much to enforce. Since then, proposals to bring estate tax back have consistently been rejected or dropped for similar reasons, most recently by the Trajtenberg Commission in 2011. Trajtenberg was concerned that any estate tax would deter potential Olim, immigrants, from making aliya.
All that seems about to change. The 2013-2014 budget of the Israeli government now passing the Knesset intends to introduce a back-door estate tax for trusts commonly found in families with its members living in Israel and elsewhere. That must affect much of the Jewish world.
A trust is an arrangement whereby someone holds assets for someone else. This is commonly used to make sure the family fortune amassed by Dad isn’t frittered away by the children.
What’s planned? In a nutshell, trusts are currently exempt from Israeli tax on foreign income and gains if they were set up by foreign residents for the benefit of beneficiaries living in Israel or abroad. This assumes certain conditions are met – in particular the beneficiaries don’t exercise control or influence over the trust.
This type of trust is referred to as a “Foreign Residents’ Trusts.”
Commencing January 2014, Israel is to tax the worldwide income of such trusts if they have an Israeli resident beneficiary.
The taxpayer will usually be the trustee, even if he is based abroad.
These are referred to as “Israeli Resident Beneficiary Trusts.
How much trust will an IBRT pay? The trustee can choose how much tax to pay and when, but it will apparently work like Russian roulette. If the settlor (grantor) is still alive and related to the beneficiary, the Trustee would choose between: (1) 25 percent tax on trust income in the year it is earned if it is attributed to Israeli resident beneficiaries, or (2) 30% tax if and when trust income is actually distributed to Israeli resident beneficiaries.
But when the settlor dies, the Trustee must start paying tax at regular Israeli tax rates (25%-50% expected) on worldwide trust income in the year it is earned unless all the beneficiaries reside outside Israel. This is because upon death of the settlor, the trust is reclassified for Israeli tax purposes as an “Israeli Residents’ Trust.”
All these trust name changes may sound technical, but they add up to a death tax aimed mainly at immigrants.
Will it work? Probably not. According to Israel’s Central Bureau of Statistics, transfers from abroad to private individuals in Israel amounted to: $3.068 billion in 2009, $3.026b. in 2010, $3.350b.
in 2011 and $3.071b. in 2012. Much of this money is thought to be channeled into Israel via family trusts. These inflows into the economy seem likely to stop if there is an tax impediment.
This is not a prediction, this is déjà vu. Around 11 – 12 years ago, billions of dollars stopped flowing into hi-tech when Israel tried to tax the capital gains derived by venture capital funds that were the usual channel for such investments. In 2003, the then Finance Minister, Binyamin Netanyahu, realized the damage being done and stopped taxing the venture capital funds on high tech gains.
Just to put the figures into perspective they are more than US foreign aid to Israel: $2.089b. in 2009, $2.774b. in 2010, $2.964b.
in 2011 and $3.003b. in 2012 Is it right? The new law is tax discrimination against immigrant families, but it isn’t illegal if the Knesset allows it.
What should affected families do? Affected families should of course obtain professional advice. Following are a few general non-exhaustive tips to consider.
First, check whether the trust is documented in writing and what are the terms. Verbal trusts are still trusts, but it may be prudent to carefully document them to avoid unintended tax consequences in one country or another.
Second, find out whether the trust needs to be discretionary, i.e. the beneficiaries and their entitlement are at the discretion of the Trustee.
Third, see whether it would be prudent to hive off foreign resident beneficiaries to a separate trust with separate assets outside the sights of the Israeli Tax Authority.
Fourth, the new rules may tax past income – consider what action to take before the new rules take effect.
Fifth, the new rules provide a strong tax incentive for potential trust beneficiaries to make yerida (emigration) from Israel, not aliya (immigration) to Israel. That is indeed a sad fact.
As always, consult experienced tax advisers in each country at an early stage in specific cases.[email protected] Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.