Your Taxes: Trustees and trusts

Will foreign trustees report and pay Israeli taxes as required under Israeli tax law?

taxes good 88 (photo credit: )
taxes good 88
(photo credit: )
One of the unsolved mysteries of the Israeli tax world has been puzzling tax practitioners for some time: will foreign trustees report and pay Israeli taxes as required under Israeli tax law? The answer: they might not have to. First, a quick re-cap. A trust is an arrangement in which a settlor (or "grantor" - such as 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 (such as a wife, children, grandchildren). In 2006, Israel introduced a comprehensive new tax regime for trusts. The aim is to impose Israeli tax each year on the worldwide income of trusts settled by Israeli resident settlors and requiring the trustee to report and pay the Israeli resulting tax ("Israeli Residents' Trust"). For additional details, see "Trusts - Has the Israeli Tax Authority got it right?" (Jerusalem Post, September 26, 2007). The people put on the spot are the trustees. Trustees are deemed "assessable and chargeable" and thus responsible for reporting and paying Israeli tax on trust income "even if the trustee is a foreign resident or if the trust is governed by the rules of foreign law." If they don't, they are punishable. This provision stirred controversy and incredulity. Now, changes have been made in Amendment 165 of the Income Tax Ordinance which was enacted on May 27 and published on June 11, 2008 (Sefer HaHukim 2154), and reads as follows: - the trustees will not always be "assessable and chargeable"; - a notice may suffice instead of tax returns; - responsibility may now be passed to the settlor or beneficiaries. Furthermore, regulations have just been promulgated that may mitigate Israeli taxation where some but not all the beneficiaries are non-Israeli residents. In addition, at a conference of the Society of Trust & Estate Practitioners ("STEP") on June 18, 2008, the Director of the Israeli Tax Authority announced that an optional transitional arrangement will soon be available for certain trusts formed before 2006. It seems they may be allowed to pay tax at a rate ranging from 4 percent to 10% of their fair market value as of January 1, 2006; their assets will then be "stepped up" to this value for future capital gains tax purposes. Let's review some of these new developments. First, under Amendment 165, the "assessable and chargeable" status may be transferred back to an Israeli resident settler ("representative settler") in the case of an Israeli Residents' Trust; and to an Israeli resident beneficiary ("representative beneficiary") in the case of a Testamentary Trust. Main conditions: - there are no Israeli resident trustees; - the trustee elects this and undertakes to deliver to the representative all necessary information to attain full knowledge of income and assets of the trustee; - all the settlers/beneficiaries also elect this; - the election by each is made on a form attached to the annual tax return for the first year this is to apply to; - the election applies to subsequent years so long as the representative is alive and resident in Israel and there is no Israeli resident trustee; - final unpaid tax debts may be collected from the Trustee (and from other settlors irrespective of where they reside if a representative settler didn't pay). In certain cases it may be enough to file a trust notice instead of a tax return. The trustee must file a trust notice in the following cases: - inception of testamentary trust within 90 days; - change of type of trust or termination of an Israeli Residents' Trust or Testamentary Trust by the following April 30 or the due date for filing a tax return if required. If the settlor elected to be "assessable or chargeable" he must file this notice. An Israeli resident settlor must file a trust notice in the following cases: - if he formed a trust or contribute an asset or income to a trust within 90 days; - if a settlor becomes an Israeli resident and an existing trust changes its status from a Foreign Resident Settlor trust to an Israeli Residents' Trust or a Foreign; Resident Beneficiary Trust by the following April 30 or the due date for filing a tax return if required. The notice will include assets and income contributed by the settlor to the trust in the five years before he became an Israeli resident. An Israeli resident beneficiary must file a trust notice if he received a trust distribution other than money, even if it is not taxable, by the following April 30 or the due date for filing a tax return if required. Given the above, who now has to file an annual tax return? The list now includes the following: - the trustee of an Israeli Residents Trust or an Israeli resident Testamentary Trust (the latter having at least one Israeli resident beneficiary) - but if a settlor or beneficiary are elected to be "assessable or chargeable", they file the return. - in the case the trustee of a trust has income or an asset in Israel, the Finance Minister is empowered to exempt trustees from filing annual tax returns if all their income is exempt from Israeli tax. When does all this start? The above notices are due 90 days after the relevant forms are published - this is expected shortly. The Amendment is retroactive to January 1, 2006. More generally, the deadline for trust reporting under the new trust regime for 2006 onwards has just been postponed by the Israeli Tax Authority until October 31, 2008. In future articles, we will discuss the abovementioned new trust regulations regarding foreign resident beneficiaries and the transitional arrangement. The above is a brief general summary of new untried legislation. 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.