At the beginning of 2006, Israel introduced a comprehensive new tax regime for trusts, which upset a lot of people. It may be fair game to tax Israelis who set up trusts purely for tax planning reasons, but it is another thing if trustees around the world must also now learn Hebrew, file Israeli trust tax returns and pay Israeli taxes. This prospect apparently caused consternation in high places in capital cities in far flung places. Lo and behold, a bill has just been submitted to the Knesset that may partly remedy the situation. Anyone with a trust in the family should follow developments closely in the next few weeks and consult their advisers. A trust is an arrangement in which a settlor (or "grantor" - e.g. the father of a family) transfers assets to a trustee (e.g. a lawyer or bank trust department) to hold and invest for the ultimate benefit of beneficiaries (e.g. wife, children, grandchildren). There may also be a protector who oversees the trustees. It is necessary to understand the main types of trust specified in the new Israeli tax regime. Briefly, they are as follows: Israeli Residents' Trust: A trust that had an Israeli resident settlor and an Israeli resident beneficiary upon formation and still has an Israeli resident settlor or beneficiary in the tax year concerned. It also includes other trusts not falling into one of the categories below. This type of trust is taxed in Israel at rates of 20 percent-48% on its worldwide income, even if the trust is irrevocable and discretionary, even if some of the beneficiaries reside outside Israel. Foreign Resident Settlor Trust: A trust formed entirely by non-resident settlors, or a trust that has non-resident settlors and beneficiaries in the tax year concerned. Non-Israeli source income may be exempt from Israeli tax if certain conditions are met. In particular, beneficiaries must not have control or influence over the conduct of the trust. Foreign Resident Beneficiary Trust: A trust formed by an Israeli settlor exclusively for foreign resident beneficiaries. Non-Israeli source income may be exempt from tax reporting in Israel if certain conditions are met. Testamentary Trust: A trust created via a will by one or more persons who were Israeli residents upon their death. If any beneficiary is an Israeli resident, the Testamentary Trust will be deemed to be Israeli resident and subject to Israeli tax on worldwide income. Otherwise non-Israeli source may be exempt from tax in Israel if certain conditions are met. What's new? The Bill for the Amendment of the Income Tax Ordinance, 2007, was submitted to the Knesset for debate and possible legislation on December 17 (bill No. 349) and has passed its first reading. Its objective, tucked away in a footnote (on page 270), is to require annual income tax returns from types of trust where there is a high probability that the transactions conducted by the trust are subject to Israeli tax. But in other cases, notices (as opposed to annual income tax returns) will still be required and the scope of "transactions" subject to Israeli tax remains broad. The Israel Tax Authority announced Sunday that the trust reporting deadline has been postponed until May 31. We also await the publication of regulations, guidance and forms. What are the proposed new obligations of trustees? According to the proposals in the bill, trustees will need to file notices with the Israel Tax Authority in the following cases: inception of a testamentary trust - within 45 days; change in the type of trust - by April 30 after the end of the year concerned; end of an Israeli Residents' Trust or an Israeli resident Testamentary Trust or any trust with assets in Israel - by April 30 after the year-end or attached to an annual tax return. Trustees will also have to file annual trust tax returns and pay Israeli tax on trust income and gains in each of the above cases, and in any other case if the trust has income in Israel, according to the proposals. In principle, these obligations will apply to trustees around the world. The only exceptions provided are cases where elections to be taxed are filed by Israeli resident settlors of revocable trusts. They will then assume the trustee's reporting requirements. Israeli resident settlors: According to the proposals, Israeli resident settlors will have to file a notice (as opposed to a tax return) with the Israel Tax Authority in the following cases: if they form a trust or contribute assets to a trust - within 30 days; if they take up Israeli residence and thereby change the status of the trust - by April 30 after the year concerned. This proposal has been criticized as discouraging aliya and returning residents. Settlors will not need to file an annual tax return unless they are required to under the general Israeli tax rules for filing returns. Foreign resident settlors will not be required to file an Israeli tax return under the proposals. Israeli resident beneficiaries: According to the proposals, Israeli resident settlors will have to file a notice (as opposed to a tax return) with the Israel Tax Authority if they receive any distribution from a trust, except cash, by April 30 after the end of the year concerned. Beneficiaries will not need to file an annual tax return unless they are required to under the general Israeli tax rules for filing returns. Foreign resident beneficiaries will not be required to file an Israeli tax return under the proposals. How to report: The relevant forms have not yet been published, but the bill specifies a long list of things to be included, such as name and residence of the settlor, name and residence of the protector, assets contributed to the trust or distributed from it (including Israeli real estate assets), names and residence of the recipients of assets or income distributed, etc. What about timing? Trust reporting under the new regime has been repeatedly postponed. The latest postponement announced by the Israeli tax authority expires on May 31 - this is according to a letter on Sunday from the director of the Tax Authority to the president of the Institute of Certified Public Accountants in Israel. The bill has passed its first reading in the Knesset and has been sent to the Knesset Finance Committee for consideration. It provides that the above-mentioned notices must be filed within 60 days after publication of the law or publication of the relevant forms, whichever is later. The aim is for the bill to be legislated shortly, but it remains to be seen when it will be legislated and what will be its final terms. Comments: The bill does not help multinational families. The above-mentioned regulations are expected to provide a partial exemption for trust income distributed to, or earmarked for, foreign resident beneficiaries. But what if the beneficiaries are unborn or not yet designated? Capital gains are a ticking time bomb. For example, Mr. Smith of New York bought an asset outside Israel in 1966 for $100,000, and contributed it to a trust that sold the asset in 2006 for $20 million. The entire accumulated capital gain ($19.9m.) in shekel terms will be subject to Israeli tax at various rates ranging up to 49%, resulting in substantial retroactive taxation. Worse still, foreign estate and inheritance taxes may be ignored. To sum up, the proposed bill and other measures may reduce the long global reach of the Israeli tax law, but not sufficiently to prevent double taxation and/or retroactive tax. Many trusts are set up for non-tax reasons - to ensure family wealth is preserved or used charitably, not frittered away. Nevertheless, the tax situation must be monitored and planned. As always, consult experienced tax advisors in each country at an early stage in specific cases. [email protected] Leon Harris is an international tax partner at Ernst & Young Israel.