Israeli Trust Law

In July 2005 the Israeli Knesset finally passed legislation concerning the taxation of trusts, effective January 1st, 2006.

What is a Trust? Someone (Grantor/Settlor) can create a trust by signing a trust deed in which he transfers legal title of his assets to a trustee, whom he designates in the trust deed. The trustee, while having legal title to the assets, has no beneficial entitlement from the assets. The trust deed names beneficiaries, who do not have legal title to the assets, but are able to enjoy the income and the assets in accordance with the terms and conditions under the trust deed. This, in a way, is a legal fiction dating back to the 11th Century, but is well grounded in English (American) common law.

The new Israeli law recognizes three different types of trusts:

Israeli resident grantor/settlor trust with Israeli beneficiaries.
Foreign resident grantor/settlor trust with Israeli beneficiaries.
Israeli resident grantor/settlor trust with foreign beneficiaries.

There is actually a fourth type of trust - foreign resident grantor/settlor trust with foreign resident beneficiaries. However, to the extent that this type of trust does not invest in Israeli assets and the grantor/settlor remains a foreign resident, there is no tax consequence in Israel.

1. Israeli resident grantor/settlor trust with Israeli beneficiaries: Israel ignores the trust as a legal entity in this particular case and taxes either the grantor or the beneficiaries. For those of you who previously created such a trust, as of January 1st, 2006, the income from these trusts will be subject to Israeli tax.

2. Foreign resident grantor/settlor trust with Israeli beneficiaries: To the extent that the grantor/settlor is a foreign resident at creation of the Trust and remains so, all foreign source income of the trust will not be taxable in Israel, even when a distribution is made to the Israeli resident beneficiaries. If the foreign grantor should move to Israel and become a resident, the income from the trust will be subject to tax as if it was in the name of the grantor, but it will enjoy the exemptions that a new resident is entitled to.

This type of trust allows for some tax planning. If you have parents, grandparents, siblings, friends and other relatives who intend to give gifts or leave inheritance for Israeli residents, Israeli taxes can be saved if the gifts and inheritance are done via a trust. However, there are potential negative U.S. tax consequences and therefore this must be done with proper advice from an Israeli and U.S. tax advisor.

3. Israeli resident grantor/settlor trust with foreign beneficiaries. This type of trust can avoid paying Israeli tax on its foreign source income if the Israeli resident grantor/settlor is prepared to give up all control over the assets and income. The trust must be irrevocable and the grantor and no other Israeli resident can or ever have rights or control over the assets or the income. However, the transfer of the assets other than cash to such a trust, will be treated under Israeli law as a sale of the assets which will be subject to capital gains.

This type of trust also allows for some tax planning for those Israeli residents who intend to give gifts and/or inheritance to non-residents, for instance, siblings, children or grandchildren. If this is a possibility in the near future, you might want to consider "virtually selling" before end of 2011 the assets intended for the Trust. (See our circular about virtual sales - "Only in Israel".)

We have intentionally simplified our explanation to convey to you the essence of the new law. The rules for each type of Trust are complicated and, in some cases, if not strictly complied with, the Trust will not be able to enjoy the intended tax benefits. Please do not try this on your own at home; consult with an appropriate tax advisor.

If you should have any questions about the above, please call our office.