Taxation of trusts – clarification from tax authority

A few weeks ago, the tax authority published a circular regarding the taxation of trusts, expanding on some of the definitions and rules set down in the revised laws as of 1.1.2014 – and including some important clarifications regarding some of the tax issues that had been raised. The entire thing is over 50 pages, so if you’re bored, take a look at the original here.

Here are some of the clarifications given:

We discussed in a previous post the issue of tax being paid on trust income by different taxpayers. The circular clarifies that, in almost all cases, the tax paid to a foreign tax authority on the trust income will be available for offset against the Israeli tax due – irrespective of whether the taxpayer in either country is the trust itself, the settlor or the beneficiary.

Where the income of a trust is taxed in the hands of the settlor or beneficiary, the income is treated as that person’s for any and all matters. This includes them being able to offset losses against the income, exemptions that may be applicable (including for disability), as well as the calculation of the tax due.

The largest area of clarifcaiton revolves around Relatives Trust (see here for more)

• Where tax is levied on a distribution basis, the income that is distributed retains its’ nature for the purposes of offsetting losses and foreign tax credits – despite being taxed at a fixed rate of 30%. Further a credit for foreign tax borne on the income will be granted. This comes with a caveat though – the requirements for a tax credit to be given relate to the income and the tax being in the same year. So where there is a distribution of a number of years’ worth of income in one go, the foreign tax paid available for use in Israel will be limited.
• If tax is levied on the income on an ongoing basis, the distribution of the taxed income is tax-free to the beneficiary. The tax authorities have made clear that any other distribution made to the (Israeli-resident) beneficiary is subject to 30% tax, as if taxed under the other method. Whilst this would make sense for income earned post the change in law, and which the trustees elected to give the Israeli beneficiary more than “their share”, the tax authority have said that even pre-change in law profits that are distributed will be subject to this 30% tax – unless the trust had applied for a step-up on their capital under the system that closed at the end of 2015. This is, in my opinion, outrageous – since the trust wasn’t subject to taxation at all before the change in the law.

If any of the above affects you, it is important to seek advice in order to consider how best to approach future decisions