STEP Israel Annual Conference

Transcription

1 STEP Israel Annual Conference Trusts Tax Planning Risks and Opportunities Ran Artzi c.p.a - Managing Partner June 2017 Artzi, Hiba, Elmekiesse, Cohen Tax Solutions Ltd

2 Taxation of a trust resident of a treaty country

3 Details of the case under discussion An Israeli resident settlor creates a trust by granting funds and/or assets to a trust "company"; for example, an entity such as a foundation, established in a treaty country and considered a resident of that foreign country. The beneficiaries in the trust are the settlor and his children, Israeli residents. The trust is managed by the board from the foreign country. The question: What is Israel s right of taxation in connection with grants to the trust, its current periodic income and distributions from it? 3

4 Provisions of the Israeli tax Ordinance The foundation is considered a trustee according to the addendum to the trusts chapter, and is considered the taxpayer (the trust s income is attributed to it). The trust is considered an Israeli Residents Trust and its income is taxed as the income of an Israeli resident individual. Grants to the trust and distributions from it are not liable to tax in Israel. 4

5 The residence of the trust pursuant to the provisions for the standard treaty The foundation is considered a resident of the treaty country: It is considered a resident of the treaty country in accordance with its internal laws. Even if the same foundation is considered an Israeli resident pursuant to the Trusts chapter (since the assets and income of an Israeli Residents Trust are treated as assets and income of an Israeli resident individual), the tiebreaker rule should be examined in connection with a person who is not an individual. In most treaties, the residence of that "trust company" is determined according to the place of effective management, and it is carried out in the foreign country of residence. 5

6 The residence of the trust pursuant to the provisions for the standard treaty Israel tries to settle the status of a trust s residence in new tax treaties; for example, the new treaties with Malta and Panama: In the residence section it is determined that in the case of a trust that is resident of both contracting countries, the competent authorities will try to determine its residence by mutual agreement. In the treaty protocol, criteria have been set for examining the residence of the trust: Residence of trustee, settlor or beneficiary. Law applying to trust. Location of trust assets. 6

7 The combination of treaty provisions and provisions of internal law Israel has the right to tax the income of a treaty country resident only if this income is generated in Israel, and in certain cases this right is limited too (for example, the condition of a P.E existence in connection with business income or exemption from capital gains in Israel, limited tax rates applying to interest and dividends, etc.). One possible conclusion is that Israel has no right of taxation with respect to a foreign trust company resident of a treaty country in connection with income from abroad; or, it has limited taxation rights in connection with certain types of income derived in Israel, such as from the capital market; this, even if the trust considered an Israeli Residents Trust pursuant to the trusts chapter of the ordinance. 7

8 The combination of treaty provisions and provisions of internal law Grants of assets to a trust and distributions from it- are not liable to tax pursuant to the provisions of the trusts chapter. In cases of treaty abuse for tax avoidance purposes, Israel may apply its internal anti abuse rules (for example, section 86 of the ordinance). 8

9 Application of section 3(i1) of the Ordinance (loan to shareholder or to related transparent corporation- as a dividend) in the case of a trust

10 Provisions of the law Section 3(i1) of the ordinance (valid from 2017) sets forth provisions on the taxation of a substantial shareholder in a company who has withdrawn funds from the company: Withdrawal from the company shall be seen, on the date of charge, as the income of the substantial shareholder. The sum of withdrawal is taxed by the substantial shareholder as a dividend, as a salary or as a business income, as the case may be. Withdrawal from the company : Including a loan. Including indirect withdrawal (for example, by a sister company controlled by the substantial shareholder). Including to a relative of the substantial shareholder. Relative - as defined in section

11 Provisions of the law A loan given to another company shall not be seen as a withdrawal (for example, a sister company controlled by the substantial shareholder) if two cumulative conditions are fulfilled: The loan is used for an economic purpose in the receiving company. The receiving company is not a transparent company. Transparent company : a company whose income or taxable income is attributed to the holders of rights in it; 11

12 Implementation of the section in the case of a load to a trust A holds 100% in company A. B is the brother of A. Company A gives a loan to B. B is a relative of A; therefore, the provisions of the section apply and the receiving of loan will be taxes. 12

13 Implementation of the section in the case of a load to a trust A holds 100% in company A. B is the brother of A. B created a trust for his own benefit or the benefit of A. The trust is considered an Israeli Residents Trust. Company A gives a loan to a trustee in a trust. The trustee is a relative of B (the settlor in the Israeli Residents Trust). B is a relative of A (brothers). The trustee is not a relative of A! Therefore, the tax provisions shall not apply. This position is in line with the interpretation of the Israeli Tax Authority itself, as expressed in the taxation decision 4938/14 in which it was determined that despite the fact that the individual is a relative of his brother, and the brother is a relative of his spouse, the spouse shall not be considered a relative of the individual. 13

14 Implementation of the section in the case of a load to a trust A holds 100% in company A. A is taking a loan from the company, in order to invest in a real estate project. The basic conditions of section 3(i1) are fulfilled; thus, the withdrawal amount is taxed as income. 14

15 Implementation of the section in the case of a load to a trust A holds 100% in company A. A establishes a trust for the benefit of his children (Israeli Residents Trust). Company A gives a loan to a trustee in a trust, in order to invest in a real estate project. The trustee is considered a relative of A according to the definition in section 88. Therefore, the provisions of the section are fulfilled and the withdrawal amount is taxed as income. 15

16 Implementation of the section in the case of a load to a trust A holds 100% in company A. A is a beneficiary in an Israeli Residents Trust that he did not create (and is not the settlor of). The trustee in the trust is an Israeli company. Company A gives a loan to the trustee (the company) in order for the trustee to invest in a real estate project. The trustee is not a relative of A since A is not the settlor in the trust (a trustee is the relative of a beneficiary only in a Foreign Beneficiary Trust or in a Testamentary Trust). 16

17 Implementation of the section in the case of a load to a trust With regard to the claim of indirect withdrawal, the exception determined in section 3(i1)(9) of the ordinance (loan to a non-transparent company) prevent the taxation: The loan is used for an economic purpose in the receiving company (investment in a income-producing project); The receiving company is not a transparent company since its income is not attributed to the holders of controlling interest in it; rather, it is taxed as an independent taxpayer in a separate trust file managed in its name. 17

18 Order of distributions to a foreign beneficiary and an Israeli beneficiary in a Relatives Trust

19 Provisions of the law Section 75h1(2) sets forth the order of distributions in a Relatives Trust in the Distribution Track: Distribution of income is liable to tax at a rate of 30% at the time of distribution to the Israeli beneficiary; Distribution of "principal" (the asset originally granted by the settlor) is exempt from tax when distributed to an Israeli beneficiary; Conclusive possession: Distribution of income precedes distribution of principal; In distribution to several beneficiaries, each beneficiary receives a proportionate part in principal distribution and, respectively, a proportionate part of income distribution; 19

20 Example 1 A foreign settlor established a trust in 2014 for the benefit of his two children, one of them an Israeli resident, and contributed to it a sum of 10 million dollars (the "principal"). By the end of 2016 tax year, the trust accrued income of 2 million dollars, and since then has not accrued any more income. In 2017 the trustee distributed a sum of 4 million dollars to the two beneficiaries in equal parts. 20

21 Example 1 Implementation of the section provisions: The accrued income should be seen as if first distributed, thus: out of a 4 million dollars distribution- there are 2 million dollars of income distribution and 2 million dollars of principal distribution. Each of the beneficiaries is seen as having received a proportionate part in the principal distribution, as follows: Each of the beneficiaries is seen as having received an income distribution of 1 million dollars and a principal distribution of 1 million dollars. The Israeli beneficiary is taxed with 30% on a distribution amount of 1 million dollars (the income distribution); 21

22 Example 2 A foreign settlor established a trust in 2014 for the benefit of his two children, one of them an Israeli resident, and contributed to it a sum of 10 million dollars (the "principal"). By the end of 2016 tax year, the trust accrued income of 2 million dollars, and since then has not accrued any more income; In 2017 the trustee distributed a sum of 2 million dollars to the foreign beneficiary. In 2018 the trustee distributed a sum of 2 million dollars to the Israeli beneficiary. 22

23 Example 2 Implementation of the section provisions: With regard to the distribution of 2017, the accrued income should be seen as having first been distributed, as follows: The foreign beneficiary received 2 million dollars, all from the trust income and not from the principal. The foreign beneficiary is not liable to tax on the distribution funds given to him; With regard to the distribution of 2018, since no accrued income remained in the trust, the entire distribution is seen as having been made from the principal; The Israeli beneficiary is not liable to tax on the 2 million dollars distribution, since it was made from the principal; 23

24 Distributions to an Israeli beneficiary in the Relatives Trust

25 Distributions to an Israeli beneficiary in the Relatives Trust The question: Is a distribution in a Relatives Trust to an Israeli beneficiary from income accumulated until December 31, liable to tax? 25

26 Provisions of the law Section 75h1(d)(2) determines: Distribution from the trustee to the Israeli resident beneficiary from the income produced or generated outside of Israel shall be taxed at a rate of 30%. Later on, the section set forth the order of distributions among the income component in the trust (which is liable to tax) and the principal component (which is tax exempt). The section itself does not include any distinction within the income component, between past earnings accrued to date December 31, 2013 and new earnings accrued from January 1, 2014 and on. 26

27 Provisions of the law Section 42(f) of the budget law of 2013 and 2014 as part of which amendment 197 to the ordinance was introduced and a definition of Relatives Trust was added, set forth "coming into force provisions of amendment 197 in connection with trusts: (1) Provisions of the fourth chapter 2 of the ordinance, in the version of after amendment 197 shall also apply to a trust established before... January 1, , with regard to trustee income produced or generated on... January 1, 2014 and on... " 27

28 Provisions of income tax circular No. 3/2016 In section 6.2 of the circular (relatives trust, distribution track) it is determined that: When distributing to a beneficiary, the distribution shall be seen as if having been made first from the trustee income accrued from Januay 1, 2014 until the distribution date (hereinafter: the Profit Component ) and only after this shall the principal component be seen as having been distributed ; As stated, the Profit Component shall be liable to 30% tax whereas the principal component shall be exempt from tax ; 28

29 Provisions of income tax circular No. 3/2016 It should be noted that the profit component should be seen as if it had been distributed before the income and assets of the trustee accrued before January 1, 2014 were distributed ; Summary: The new profit component (income accrued from January 1, 2014) is liable to 30% tax and is distributed first; The principal component is exempt; With regard to the old profit (income accrued until December 31, 2013), no taxation provisions exists in section 6.2 of the circular. 29

30 Provisions of income tax circular No. 3/2016 Subsection of the circular (under the subject: relatives trust - income designation track ) states that: A distribution to a beneficiary at the sum of the trustee s income which was designated to beneficiaries as stated and was taxed at a rate of 25%- shall be tax exempt; The remaining of the distribution funds which were not (previously) designated to beneficiaries, a tax rate of 30% shall apply, unless the trustee has proven that the distribution funds originate from the principal element and if so they shall be tax exempt; 30

31 Provisions of income tax circular No. 3/2016 It should be clarified that the stated exemption shall not apply to distributions originating from income produced or generated prior to amendment 197 of the ordinance, unless this matter has been settled as part of the transitional arrangements to Israeli Resident Beneficiary Trusts, published by the Tax Authority on February 19, 2014; 31

32 Provisions of income tax circular No. 3/2016 Corresponding to that stated, the Tax Authority seeks to tax those who have not reached a transitional arrangement with it, and retroactively, on income accrued prior to amendment 197 coming into effect, contrary to the coming into force provisions of amendment 197 in connection with trusts; 32

33 Provisions of income tax circular No. 3/2016 Does the fact that the retroactive tax provision is included in section 6.3 of the circular ( relatives trust, income designation track ) imply that those who do not choose the income designation track and are taxed only according to the distributions track are exempt from that retroactive tax? It seems that in a trust changed in 2014 from a Foreign Settlor Trust to an Israeli Residents Trust (for example, if the settlor is deceased), there is no legal clause that taxes distributions to an Israeli beneficiary, whether a transitional arrangement has been signed with that trust or not. 33

34 Thank you Ran Artzi, CPA - Managing Partner artzi@ahec-tax.co.il Artzi, Hiba, Elmekiesse, Cohen - Tax Solutions Ltd. Ramat - Gan: Tel: , Fax: Haifa: Tel: , Fax: