Beware the ingathering of trusts into Israeli tax net

There has been a dramatic change in the nature of aliya in the 21st century. No longer is Israel just seen as a refuge for the homeless and persecuted Jews of the world, today it has become an attractive haven for wealthy Jews seeking to protect their assets from foreign tax authorities.

According to New World Wealth’s global migration review, over the past few years, Israel has consistently ranked in the top 10 migration destinations for high-net-worth individuals, with more than 1 000 dollar millionaires making aliya every year. Some notable billionaire olim include Australian Westfield shopping centre owner Sir Frank Lowy; former Chelsea football club owner Roman Abramovich; and Laurent Levy, the French founder of global eyewear chain The Optical Center.

While the Tel Aviv nightlife and Israel’s vibrant start-up scene are attractive, Israel’s favourable tax laws for olim have also been a big draw card. Israel legislated a 10-year tax exemption on all foreign income and capital gains for new and returning olim in 2007. Conveniently, no disclosure of foreign assets is required.

However, all good things come to an end, and many wealthy families, without proper tax planning, can be caught out after 10 years by Israel’s extensive tax net. Nowhere is this more evident than with offshore trusts.

History and purpose of trusts

The land of Israel and offshore trusts have had a long history. The law of trusts was first developed in the 12th century from the time of the Crusades as a means for soldiers fighting in the holy land to protect their assets from being usurped while they were gone and to look after their wives and children. To this day, trusts are still widely used to protect one’s assets from disgruntled spouses, creditors, and the tax man. Moreover, they provide people with the means of ensuring how their assets should be used after they have been given away for the benefit of designated beneficiaries.

Trusts as a threat to the tax base

Over the past few decades, governments around the world have been honing in on trusts, seeing them as a threat to their tax base. This has led to tax authorities around the world designing different, wide reaching, anti-avoidance provisions targeting trusts. Israel is no straggler in this regard. Since 2014, its trust tax regime has become extremely harsh, especially for offshore trusts.

Israel has cast a very wide net with regards to the taxation of trusts. In many circumstances, offshore trusts that have even one Israeli resident beneficiary may be subject to tax and reporting requirements in Israel on their worldwide income. A trust, which is deemed to be an Israeli tax resident, will in general be subject to tax in Israel as an Israeli resident on its worldwide income at the highest marginal tax rate (50%). However Israel does have lower tax rates for specific types of passive income depending on the circumstances.

Take, for example, the case in which many years ago, a wealthy South African set up a South African trust for the benefit of his numerous descendants. One of the many beneficiaries of the South African trust decides to make aliya. Some years later, the founder of the trust passes on. Even though he was never an Israeli tax resident, the trust is in South Africa, and the vast majority of the beneficiaries are South African, Israel’s harsh trust tax laws deems this trust to be an Israeli resident trust. Consequently, all the income of the trust, not just the portion relating to the one Israeli beneficiary, will be taxable and reportable in Israel.

Depending on the jurisdiction of the trust, there may be a double tax agreement with Israel that can dampen the financial blow. However, the legal complexity of the trust structure and varying approaches of different jurisdictions to which parties to tax could result in additional tax even where a double tax agreement exists.

Time to get your affairs in order

Israel’s ten-year tax holiday for olim can provide some time to get your trusts in order. This tax relief also covers trusts. Where a foreign founder of the trust or foreign beneficiary makes aliya and consequently the trust becomes an Israeli resident trust, the trust won’t be subject to Israeli tax on its non-Israeli source income for 10 years. However, determining when the clock starts is complicated, owing to the movements of the multiple connected parties associated with the trust. In the case of only one party having been in Israel for more than 10 years, the 10-year tax holiday might not apply.

People with trusts where there are Israeli-related parties and connections should beware, plan ahead, and consult with a tax practitioner who can highlight the risks and navigate the pitfalls. Pre-emption is always better than rectifying costly mistakes.

• Michael Kransdorff is a Harvard educated international tax practitioner, and Laura Sassoon is a chartered accountant and former senior lecturer at the University of the Witwatersrand. They run the Institute for International Tax and Finance.