- An Israeli resident settlor created a trust in a foreign treaty country, with Israeli resident beneficiaries. - The trust income is taxed in Israel as income of an Israeli resident, however grants to the trust and distributions from it are not taxed. - Israel can tax income earned in Israel by the foreign resident trust, and may have limited taxation rights on certain types of Israeli-source income based on the relevant tax treaty.

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

2. Artzi,Hiba,Elmekiesse,Cohen
Taxation of a trust resident
of a treaty country

3. Artzi,Hiba,Elmekiesse,Cohen
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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?
Details of the case under
discussion
3

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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.
Provisions of the Israeli
tax Ordinance
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5. Artzi,Hiba,Elmekiesse,Cohen
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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.
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The residence of the trust pursuant to
the provisions for the standard treaty

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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
The residence of the trust pursuant to
the provisions for the standard treaty

7. Artzi,Hiba,Elmekiesse,Cohen
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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
The combination of treaty provisions
and provisions of internal law

8. Artzi,Hiba,Elmekiesse,Cohen
www.ahec-tax.co.il
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).
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The combination of treaty provisions
and provisions of internal law

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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

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www.ahec-tax.co.il
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 88.
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Provisions of the law

11. Artzi,Hiba,Elmekiesse,Cohen
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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;
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Provisions of the law

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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.
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Implementation of the section in
the case of a load to a trust

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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.
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Implementation of the section in
the case of a load to a trust

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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.
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Implementation of the section in
the case of a load to a trust

15. Artzi,Hiba,Elmekiesse,Cohen
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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
Implementation of the section in
the case of a load to a trust

16. Artzi,Hiba,Elmekiesse,Cohen
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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).
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Implementation of the section in
the case of a load to a trust

17. Artzi,Hiba,Elmekiesse,Cohen
www.ahec-tax.co.il
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
Implementation of the section in
the case of a load to a trust

18. Artzi,Hiba,Elmekiesse,Cohen
Order of distributions to a
foreign beneficiary and an
Israeli beneficiary in a
Relatives Trust

19. Artzi,Hiba,Elmekiesse,Cohen
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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
Provisions of the law

20. Artzi,Hiba,Elmekiesse,Cohen
www.ahec-tax.co.il
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
Example 1

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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
Example 1

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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.
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Example 2

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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
Example 2

24. Artzi,Hiba,Elmekiesse,Cohen
Distributions to an Israeli
beneficiary in the
Relatives Trust

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The question:
Is a distribution in a Relatives Trust to an
Israeli beneficiary from income
accumulated until December 31, 2013-
liable to tax?
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Distributions to an Israeli beneficiary
in the Relatives Trust

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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
Provisions of the law

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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, 2014..., with
regard to trustee income produced or generated
on... January 1, 2014 and on... "
27
Provisions of the law

28. Artzi,Hiba,Elmekiesse,Cohen
www.ahec-tax.co.il
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
Provisions of income tax
circular No. 3/2016

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“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
Provisions of income tax
circular No. 3/2016

30. Artzi,Hiba,Elmekiesse,Cohen
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Subsection 6.3.3 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;
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Provisions of income tax
circular No. 3/2016

31. Artzi,Hiba,Elmekiesse,Cohen
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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
Provisions of income tax
circular No. 3/2016

32. Artzi,Hiba,Elmekiesse,Cohen
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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
Provisions of income tax
circular No. 3/2016

33. Artzi,Hiba,Elmekiesse,Cohen
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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
Provisions of income tax
circular No. 3/2016

34. Artzi,Hiba,Elmekiesse,Cohen
Thank you
34
Ran Artzi, CPA - Managing Partner
artzi@ahec-tax.co.il
Artzi, Hiba, Elmekiesse, Cohen - Tax Solutions Ltd.
Ramat - Gan:Tel: 03-6134111, Fax: 03-6133113
Haifa:Tel: 04-9118181, Fax: 04-9118188