Many residents of English-speaking countries have established or are considering setting up a trust, or are the beneficiaries of trusts established by their parents.
The reasons for establishing trusts vary between families and settlors, including asset-protection, and the reduction or elimination of inheritance or estate taxes, among others. Nonetheless, based on my experience assisting new immigrants to Israel from the US, Canada, South Africa and other English-speaking countries, the main reason for establishing trusts is to avoid the probate or intestate procedures, which are usually expensive, deprive the family of the discretionary procedure and increase the likelihood of igniting family feuds.
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For the beneficiaries of these living trusts, becoming an Israeli resident after making aliyah automatically places the trust at a huge tax disadvantage, even though said disadvantage is deferred until the end of the 10-year tax holiday currently available to new immigrants to Israel.
Israel has no inheritance, estate, or gift tax, meaning that the transfer of assets owned by an Israeli resident to their inheritors will not be taxed on the estate level or the inheritors' level.
In contrast, if the beneficiary of a trust becomes an Israeli resident, the asset in the trust would automatically "enter" the Israeli tax net, and any income generated would become subject to reporting and tax payment obligations. Please note that any applicable taxes would only be levied following the 10-year tax holiday for new immigrants.
Therefore, although the assets in the trust were to be transferred to the beneficiaries upon the demise of the settlor, or to a beneficiary during the lifetime of the settlor under certain circumstances (i.e. in order to assist the beneficiary in purchasing a residential apartment, medical needs etc.), those assets would now be considered part of the Israeli tax net as though they were owned by the Israeli-resident immigrant beneficiary. Not only is the trustee now obligated to file tax returns for the trust, but they are also liable for the taxes on the taxable income of the trusts.
Section 75H1(D) allows for a trustee of an "Israeli Resident Beneficial Trust" as described, to pay either 30% tax on any distribution paid to the beneficiary on the taxable income distributed, or an annual 25% tax on the annual taxable income attributed to the beneficiary.
To his chagrin, the beneficiary, who is now an Israeli resident, may face an even worse scenario, in which the settlor passes away after the beneficiary's immigration to Israel. The trust then becomes an "Israeli Resident Trust", which means that the entire trust's income is taxable in Israel, even if there are additional beneficiaries who do not live in Israel.
What are the solutions? The easiest approach (which is not always available and used purely for the tax issue), would be to allow the succession of assets to an immigrant beneficiary via a will and not by way of a trust mechanism. Regretfully, this solution seems to be the Israeli Tax Authorities' plan.
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However, if the settlor of the trust is unwilling for his estate to undergo an intestate or probate procedure, or if the settlor is weary of Estate or Inheritance Tax, it is imperative that specific wording is included in the Declaration of Trust, or Trust Deed, to help mitigate some of the tax risks we are discussing. These may include provisions allowing for the potential beneficiaries of the trust to become beneficiaries only after the passing of the settlor, and establishing sub-trusts allowing for each beneficiary to be the sole beneficiary of a trust, so that he doesn't become an Israeli Resident Beneficiary of an Israeli Resident Trust, which would render the entire trust fund liable for taxation in Israel.
Boaz Feinberg heads the tax practice at Tadmor-Levy & Co. Law Offices.
