YOUR TAXES: Home sweet home - in trust

The court pointed out that the list of exemptions in Section 3 of the Real Estate Law are not a closed list; the exemptions in the Income Tax Ordinance were simply enacted later.

money (photo credit: REUTERS)
(photo credit: REUTERS)
An Israeli district court has just ruled that a transfer of Israeli real estate into a trust is not a taxable event (Gliss v. Land Appreciation Tax Director Tel-Aviv 1, 49026-07 of 24.7.19). The case caused ripples because it addressed both points of principle and the bureaucratic mindset of the Israeli Tax Authority (ITA).

In Israel, taxes on Israeli real estate are contained in the Real Estate Taxation Law, which is separate from other taxes in the Income Tax Ordinance, and never the twain shall meet. Different tax officials administer Israeli real estate, with a view to preventing the transfer of title to Israeli real estate until taxes are paid. Purchasers pay purchase tax (mas recisha) at rates of 0% to 10%, and sellers pay Land Appreciation Tax (mas shevach) on their gain usually at 28%, sometimes at rates up to 50%.
This case upset the apple cart. It forced the real estate tax officials to open up the Income Tax Ordinance, which is uncharted territory to them. The court in a lengthy judgment explained to them why.
Facts of the case

In 2016, a Canadian resident couple contributed two apartments in Tel Aviv to a discretionary trust for the benefit mainly of Israeli residents. The trust was taxable on its income either as a Relatives Trust (25%-30% tax on income) or an Israeli Resident Beneficiary Trust (various tax rates) for Israeli income tax purposes.

The issue

The issue related to the initial contribution of the two apartments in Tel Aviv into the trust. Were the Canadian resident couple liable to land appreciation tax on the initial contribution of the two apartments? And was the trustee liable to purchase tax on that contribution to the trust? The different tax laws pointed to conflicting answers: yes and no.
On the one hand, the Real Estate Taxation Law (Section 3) taxes a sale of real estate with certain exemptions relating to a contribution of assets to a trustee pursuant to the bankruptcy law and certain other specific laws, but the Income Tax Ordinance is not mentioned as one of these exemptions.
On the other hand, the Income Tax Ordinance (Section 75G) says that a contribution  of assets – including real estate in Israel or abroad – without consideration to an Israeli Residents’ Trust by an individual shall NOT be considered a sale liable to capital gains tax under Part E of the Income Tax Ordinance. And Section 75 H1 says that assets contributed to a Relatives’ Trust (a different type of trust) are treated like a gift from the settlor to the beneficiary. Israel generally does not tax gifts.
So the legislation is contradictory, and so are ITA pronouncements. Circular 5/2016 contradicts Ruling 3324/12 on real estate contributed to a trust.
The court had to sort out a huge mess like King Solomon.
What did the court decide?
The court pointed out that the list of exemptions in Section 3 of the Real Estate Law are not a closed list; the exemptions in the Income Tax Ordinance were simply enacted later as an amendment by the Knesset.
And the Knesset clearly intended contributions of Israeli real estate to a trust to be exempt, based on the recommendations of an ITA Committee – the Kapota Matza Committee which formed the basis of the above-mentioned amendment.
Moreover, if there is a gap in the legislative provisions, it is right to look for the most harmonious approach in the rules, in favor of the taxpayer.
The court ruled the ITA circular lacked authority to make the contribution of assets to a trust taxable. Therefore, the court ruled that the contribution of Israeli real estate to a trust is not taxable. Any tax may come at a later stage not discussed in detail in the judgment.

The court did its homework. It also took a swipe at the ITA’s circular, saying: “ITA Circular 5/2016 on trust taxation does not bind the court, and it seems the ITA ‘bestowed’ upon itself the authority of the legislature” i.e. it was trying to circumvent the Knesset.
It remains to be seen whether the ITA appeals the case or initiates a proposed amendment. They probably will, otherwise there will be a major new loophole. Families should consider with their advisers whether their will and trust arrangements meet the intricacies of Israeli (and foreign) legislation.
As always, consult experienced tax advisers in each country at an early stage in specific cases.
The writer is a certified public accountant and tax specialist at Harris Horoviz Consulting & Tax Ltd. [email protected]