Offshore Trusts for Israeli Beneficiaries
Under what condition will an offshore trust still fall within your government’s tax net?
Offshore trusts may be established and managed in many jurisdictions. In most countries personal taxation is based on residence. The question often asked is what the residency of an offshore trust established by a resident of a certain country is. In the case recently reported in Canada “Fundy settlement, Canada, 2012 SCC 14” (Tim Gestnick – The Globe and Mail Apr. 18), the trust had residency in the Bermudas. The trust sold shares to an Ontario Corporation and realized substantial capital gains in the amount of USD 152 Million.
The court ruled in favour of the Canadian tax collector, claiming that the tax due to the Government should be paid in Canada as the trust should be considered a resident of Canada since the central management and control of the trust in this case was carried out by the main beneficiaries of the trust who were resident in Canada. The trustees in Bermuda were considered to be carrying out an administrative function only.
What would be the case if a similar situation occurred in Israel?
Under the Israeli law for taxation of trusts the location of the trustee is not relevant for the question whether the trust should be taxed in Israel or elsewhere. The decisive criterion is who the settlor of the trust is. The law distinguishes between Israeli settlor trusts (a trust where the settler is an Israeli resident) and foreign settler trusts. In the first case, the trust is subject to taxes in Israel and the trustee is obliged to file tax reports in Israel even if the trustee is located outside of Israel.
In case of a foreign settlor trust, the trust is not subject to taxes on any transaction taking place outside of Israel. This even applies if the trustee of this trust is located and conducts business in Israel. This may be considered an exception to the international accepted concept applied to companies – the management and control test. In the above reported Canadian case, the court applied this test to the trust which claimed to be resident in the Bermudas.
The great advantage of the foreign settlor trust in Israel is that if the trust has Israeli beneficiaries, any cash distribution to them will be tax free in Israel.
However, the Israeli law has a number of anti-avoidance rules as an exception to the general rule. One of them is that if the Israeli beneficiaries are involved in the management of the trust or the assets of the trust, the trust will ¨lose¨ its tax free status and will be considered an Israeli settler trust subject to taxes in Israel.
As you can see, the Israeli legislation for taxation of trusts would treat the profit described above as profit accrued in Israel even if the assets sold were not located in Israel and the resulting capital gains were theoretically tax exempt in Israel.