New regulations that aim to exempt trust income to the extent that the income is DISTRIBUTED or ALLOCATED to foreign-resident beneficiaries have been issued. The regulations will be potentially relevant to a taxable Israeli Residents' Trust or an Israeli Resident Testamentary Trust. An Israeli Residents' Trust is broadly defined: It is almost any trust that was not formed by a non-Israeli resident settlor (Foreign Resident Settlor Trust) or formed exclusively for the benefit of non-Israeli resident beneficiaries (Foreign Resident Beneficiary Trust). A Testamentary Trust is a trust created via a will by one or more persons who were Israeli resident upon their death, with at least one Israeli resident beneficiary. There are two sets of regulations - the Distribution Regulations and the Allocation Regulations. The Distribution Regulations - for Privileged Trusts The distribution regulations are formally known as Income Tax Regulations (Provisions for Amending Assessments of the Income of a Trustee and Determination of a Capital Gain to it Following a Distribution to a Foreign Resident Beneficiary), 2008. The Distribution Regulations deal with income distributed to a foreign beneficiary. If such income was derived from non-Israeli sources, it will be considered exempt and tax assessments in the current or four preceding tax years will be amended accordingly, resulting in a refund of any Israeli tax paid (presumably with interest). The Distribution Regulations are subject to a number of conditions. In particular, the trust must be irrevocable (as defined) and capital gains tax must be paid on the unrealized gain as of the end of the tax year preceding the first such distribution and on all subsequent asset contributions into the trust. The Allocation Regulations - for Dedicated Trusts The Distribution Regulations are formally known as Income Tax Regulations (Allocation of Income to an Individual Foreign Resident Beneficiary and Determination of a Capital Gain in a Dedicated Trust), 2008. The Allocation Regulations allow a trustee to submit to the Israel Tax Authority an irrevocable declaration allocating income to specific foreign "dedicated beneficiaries." If such income is derived from non-Israeli sources, it will be considered exempt thereby reducing the trust's tax liability for the current and future tax years. (This is different from the Distribution Regulations where tax on income is first paid then refunded upon a distribution to a foreign beneficiary). The Allocation Regulations are subject to a number of conditions. In particular, the trust must be irrevocable (as defined) and capital gains tax must be paid on the unrealized gain as of the end of the tax year preceding year of commencement and on all subsequent asset contributions into the trust. In addition, after every four years, a check is carried out to see if the amounts allocated to foreign "dedicated beneficiaries" were actually distributed to them. Any under-distribution is taxed at a penal rate of 70 percent! (It is assumed that Israeli residents must have benefited instead). The year of commencement is the year after the trustee files his declaration or the same year if the declaration is filed within three months after the trust was formed. The net effect of the Allocation Regulations is to turn a discretionary trust into a fixed-interest trust. But it is not possible, apparently, to allocate capital to one beneficiary and income to another. And there may be a heavy price for not actually paying a beneficiary his full allocation. The Distribution and Allocation Regulations may be elected for tax years commencing January 1, 2006. It should be noted that trust reporting regarding 2006 and 2007 has been generally postponed until October 31, 2008, according to a separate announcement dated June 23, 2008, from the Israel Tax Authority. Is it worthwhile opting for these regulations? Not always. Careful evaluation is needed as various other alternatives may be worth considering. As always, consult experienced tax advisors in each country at an early stage in specific cases. email@example.com Leon Harris is an international tax partner at Ernst & Young Israel.