Taxation of trusts - part 2, Revocability

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The trust laws relate to the revocability of the trust. This can affect which type of tax rules apply to a particular trust (see here for the introduction to trust taxation).

This post will consider what makes a trust revocable or irrevocable from the point of view of the Israeli tax law. In subsequent posts we will see how and when this becomes relevant.

A trust is considered irrevocable if it is not a revocable trust. The following is a list of situations whereby a trust is considered revocable. Only one of these situations need to apply for the trust to be considered revocable:

1. It is possible to cancel the trust or otherwise revert the ownership of the trust assets or incomes to the settlor, their spouse or a corporation controlled by the settlor.

2. The settlor or their spouse are, or can become, one of the beneficiaries.

3. A child, aged 18 or under, of the settlor is a beneficiary - provided that the settlor or their spouse is still alive.

4. A company controlled by either the settlor, their spouse or their child aged 18 or under, is a beneficiary.

5. The trustee is a settlor.

6. The trustee is a close relative of the settlor. This is unless it can be shown that the settlor had no undue influence on the decision making of the trustee.

7. The identity of a beneficiary is unknown. This is unless it can be shown that the unidentified beneficiary is NOT the settlor, their spouse, their child aged 18 or under or a company controlled by one of the above.

8. Beneficiaries were added or exchanged against the terms of the trust deed.

9. The relevant reports were not made for an irrevocable trust.

This last point can make it crucial to ensure that planning is done with relevant professionals before the trust goes into effect.

Taxation of trusts - part 1, Introduction and Definitions

In August 2013, the taxation of income within trusts underwent a huge reform, with a vast array of changes to the pre-existing law. The law came into effect as of 1st January 2014, but there are still a number of unresolved issues; particularly pertaining to foreign tax credits.

The following posts will look at the types of trust set out in the tax law, and the various options for how the trust income is to be taxed in Israel. This post will deal with some background and defintions.

So, what is a trust?

Without going into the fine legal detail, a trust exists when someone holds onto assets for the benefit of someone else. A classic example would be when a lawyer holds monies on behalf of a client to be used at a later date (e.g. a conveyancing deal). The person holding the asset, "trustee" does so at the request of the "settlor" (or "grantor"), with the assets or income generated theron being for the ultimate benefit of the "beneficiary".

The trust is governed by the "trust deed" in which the settlor directs the trustee how to run the trust; e.g. how to invest the funds, under what circumstances monies can/should be released to the beneficiaries, etc. There is no set format for such documents, although most countries around the globe have laws governing some of the basic rules and responsibilities. Many countries which are considered to be tax shelters have fairly advanced rules and regulations; those in Israel are fairly simple. What this adds up to is that many trust deeds will be governed according to the laws of a country foreign to all components of the trust!

Trusts are a particularly popular and effective way of managing wealth on an inter-generational level, as well as having useful tax and legal consequences.

The tax law sets out definitions as follows:

Settlor - a person who transfers assets to the custody of the trustee. The transfer must be made for no consideration (otherwise it is considered a sale). A controlling shareholder is also considered a settlor if the company that they control transferred the assets to the trustee. There are of course a few other nuances as well for more complicated scenarios.

Trustee - the person to whom the assets have been given over to look after. The trustee is the legal owner of the assets, but they are not his/hers; they are held "on trust" for the benefit of the beneficiaries. For this reason, a trustee may decide to open up a Company for holding Trust Assets, whose sole purpose is to keep the ownership of the assets that were transferred to the trust out of the name of the trustee. This is particularly popular where a trustee might be responsible for a number of trusts, and having seperate companies makes the management of the different trusts significantly easier. It should be noted that there are reporting requirements to inform the tax authority that the company has been set up purely for these purposes.

Beneficiary - the person who will be entitled to benefit from the assets or income in the trust. This could include someone who is not yet born (e.g. a trust is set up by someone for the benefit for all of their grandchildren), as well as someone who will become a beneficiary if certain conditions are met. However, a person is not considered a beneficiary if they will become one only after the passing of a settlor or beneficiary - provided of course that the particular settlor or beneficiary is still alive.