MEMORANDUM

Transcription

1 MEMORANDUM FROM: Ari Rosenberg RE: New Tax Reform July 2005 DATE: October 6, As part of the Government s new economic program, the Knesset Israel s legislature adopted a Law to amend the Income Tax Ordinance: Law to Amend the Income Tax Ordinance (No. 147), 2005, on July 25, This Law, in effect, represents a mini tax reform, following the major tax reform that came into effect on January 1, 2003, wherein Israel s tax regime was changed from territorial to personal, thus introducing taxation of Israeli residents on a worldwide basis without regard to remittance. In general, the Law is to come into effect as of January 1, Perhaps, the most significant certainly the most publicized subject in the new Law is the taxation of trusts, particularly foreign irrevocable trusts, which hitherto were virtually not taxable in Israel (see summary of new rules below). Other subjects that are covered by the law are as follows: Tax Rates on Ordinary Income Individual tax rates will be reduced annually from the current marginal rate of 49% to 44% in Corporate tax rates (flat rate) will be reduced annually from the current rate of 34% to 25% in 2010: Tax Rates on Investment Income (dividends, interest and capital gains) Resident individuals 20%, whether the source asset is traded or not, save in case where the individual is a substantial shareholder in which case the rate will be 25%, C:\Documents and Settings\TatumC\Local Settings\Temporary Internet Files\OLK1\1005 article.doc

2 - 2 - and save in the case of securities not linked to the CPI and traded on a stock exchange in Israel, in which case the rate will be 15%. Resident companies at the regular corporate tax rate (see above), except in the years when dividends and capital gains will be taxed at a reduced rate of 25% (the rate applicable today). Non-residents who are residents in a country that has entered into a tax treaty with Israel will be exempt from capital gains tax on the sale of Israeli assets that will be purchased between July 1, 2005 and December 31, 2008, regardless when the sale takes place. Today such exemption applies only to shares listed on an Israeli stock exchange or in case a particular treaty provides for it. (The exemption does not apply to dividends or interest.) Real Estate Investment Trusts ( REIT ) A real estate fund, which must be a company incorporated in Israel and listed on an Israeli stock exchange, will not be subject to tax directly, but its shareholders will be taxed on dividends received the REIT will be obliged to distribute 90% of its current income and 100% of capital gains, unless a substitute immoveable is purchased within a year as if they invested directly in the real estate and in proportion to their shareholdings. It will also need to meet the following conditions: At least 75% of the assets are income producing real estate. At least 95% of the assets are income producing real estate and financial investments. At least 75% of income-producing real estate assets are situated in Israel. The total value of the real estate assets amounts to at least NIS 200 million. Participation Exemption Non-resident shareholders of an Israeli Holding Company i.e. non-listed Israeli company with a minimum share/loan capital of NIS 50 million invested in treatycountry companies or in companies subject to a tax rate of at least 15% ( Participating Companies ), with 75% business income outside of Israel will be subject to a reduced withholding tax on dividends of 5% (instead of the normal nontreaty rate of 25%). The Holding Company will be entitled to the following benefits: Exemption from tax on dividends received from Participating Companies (12 months holding period minimum). Exemption from capital gains tax on the sale of shares of the Participating Companies. Exemption from tax on income from financial investments in capital markets in Israel. Israeli Resident Shareholder regular tax; CFC rules apply. New/Returning Resident Shareholders same tax as non-resident shareholders during period of exemption; CFC rules not applicable if participation acquired prior to immigration or return.

3 - 3 - Reporting of Tax-Planning Measures The Tax Authority may determine (in regulations) what acts it considers tax-planning measures that require reporting in the annual tax return (i.e., aggressive tax planning!). Such report entitles the assessing officer to issue a special assessment regarding the act reported. If the a final assessment determines that a particular tax planning measure is to be disqualified, the tax payer is subject to a fine amounting to 30% of the tax deficit resulting from the tax planning measure. Failure to report is subject to a fine of NIS 500 for every month of failure to report in addition to penal sanction of imprisonment and/or additional fines. Tax Rulings Upon application, tax rulings will be issued by the Israel Tax Authority in respect of the various tax laws. The rulings may deal with the tax liability of the applicant, his tax consequences or impact on his tax liability in connection with any act that he carried out or in relation to any profit, expense or loss that he incurred. Rulings may be requested before or after the transaction (except in relation to Value Added Tax Law and Taxation of Land Law only before). Ruling summaries may be published at the discretion of the Tax Authority. Value Added Tax The rate of value added tax will be reduced from 17% to 16.5% as of September 1, 2005.

4 - 4 - TAXATION OF TRUSTS Definition of Trust - An arrangement, made in Israel or abroad, according to which a trustee holds the trustee s assets for the benefit of a beneficiary, whether the law which governs it defines it as a trust or otherwise. Foundations under the laws of the Netherlands, Liechtenstein, Panama, the Bahamas and the Netherlands Antilles, and Establishments and Trust Enterprises (Trust Reg.) under the laws of Liechtenstein all are specifically included in the definition of trustees. Trusts, as defined above, are to be taxed in accordance with the following summarized rules: Liability to tax The trust income shall be deemed the trustee s income and shall be assessable to, and payable by, him. This applies both to a resident and non-resident trustee. The trustee s income shall be deemed the settlor s or the beneficiary s income. Israel resident trust If at the time the trust was created and during the tax year at least one settlor ( settlor hereinafter includes any contributor) and at least one beneficiary are Israeli residents, the trust will be deemed an Israeli resident trust and will be taxable as though the trustee s income and assets were those of the settlor. If one settlor is eligible for new or returning resident tax exemptions, then the same exemptions will apply to the trustee s income. The above liability to tax shall not apply in respect of an irrevocable trust if the income is distributed to a resident beneficiary within 6 months from the end of tax year, in which case the income of the trustee shall be deemed to be the income of the beneficiary, and not of the settlor. Foreign settlor trust If at the time the trust was created and during the tax year all the settlors are non-residents, or if during the tax year all the settlors and all the beneficiaries are non-resident, then the trust will be deemed a non-resident trust and the trustee s income and assets will deemed as those of a non-resident individual, i.e., the trustee will be subject to tax only in those cases where Israel imposes a tax on non-residents (basically Israeli sourced income). Foreign beneficiary trust If during the tax year all the beneficiaries in an inter vivos irrevocable 1 trust are identifiable non-residents and at least one settlor is an Israeli resident 1 For Israeli tax purposes, a trust is deemed revocable if any one of the following conditions exists: 1. It is possible to dissolve the trust or transfer or return an asset or income to the settlor, his/her spouse, or estate, or an entity controlled by the settlor, directly or indirectly. 2. One or more of the beneficiaries is the settlor or the settlor's spouse, or the settlor or the settlor's spouse may become a beneficiary. 3. One or more of the beneficiaries is a child of the settlor under 18 years of age, or that "there is a possibility" of distributing to such child, directly or indirectly, as long as the settlor or his/her spouse are still alive.

5 - 5 - and Israeli resident beneficiaries are excluded in the trust deed, then the trust will be deemed a non-resident trust and the trustee s income and assets will be deemed as those of the beneficiary. The resident settlor and the trustee must file a declaration (with the initial annual return) that there is no Israeli resident beneficiary, nor an Israeli beneficiary who would be entitled to benefit provided he became a non-resident, and that no such beneficiary can be added. Default definition A trust that qualifies neither as a foreign settlor trust nor as a foreign beneficiary trust is deemed an Israeli resident trust. An exception to this rule is a trust established by Will (mortis causa). (See below) Change of status Israel resident trust that ceases to be as such because it no longer meets the required conditions and becomes a foreign settlor trust, will be subject to an exit tax in the same way as a resident who emigrates. If it becomes a foreign beneficiary trust, the trustee will be deemed to have sold the assets to a non-resident on the day the Israel resident trust ceased to be as such. Foreign resident trust ceases to be as such if one of the settlors becomes a new or returning resident, in which case new or returning resident tax exemptions will apply to the trustee s income. Foreign beneficiary trust ceases to be as such if one of the beneficiaries becomes a new or returning resident, and in that case, new or returning resident tax exemptions will apply to the trust in the same way as if the income were accrued to such beneficiary directly. Trust by Will The above rules apply in respect of trusts inter vivos. If a trust is created by Will (mortis causa) where all settlors are testators who were resident on the date of death then the trustee s income and assets are deemed to be that of the beneficiary, so that if there is at least one resident beneficiary the trust will be deemed a resident trust, and if there are no Israeli beneficiaries, the trust will be deemed a non-resident trust. 4. One or more of the beneficiaries is an entity, not being a public institution, where 10% of any of the means of control of such entity are held by the settlor, by his/her spouse, or by a child under the age of 18, if the settlor or his/her spouse are still alive. 5. The trustee or the protector is the settlor or an entity as described in 4 above. 6. The trustee or the protector is a relative of the settlor, unless the Director (of the Tax Authority) has been satisfied that there was special justification for appointing the relative as a trustee and that such nomination is not intended for the purpose of directing the trustee s activities or the giving of instructions regarding the trust. 7. The settlor or his relative has the ability to direct (guide?) the acts of the trustee or give instructions on the manner of administering the trust, its assets, change of beneficiaries or distribution of the assets or income to the beneficiaries, or the settlor's approval is required for the acts of the trustee, or the settlor has the ability to direct that the trust be dissolved or the trustee changed for any reason not in law, the whole directly or indirectly. 8. The identity of one or more of the beneficiaries, or of a direct or indirect shareholder in an entity which is a beneficiary, is not known, unless the assessing officer has been satisfied that such beneficiary cannot be the settlor, his/her spouse, the child of the settlor under 18 years, or an entity as described in 4 above. 9. The beneficiaries have been changed or new ones have been added without there being provisions permitting this in the trust documents. 10. An affidavit by the settlor and the trustee declaring the trust as being irrevocable was not filed with the Assessing Officer - in the form and at the time fixed by the Director.

6 - 6 - Tax collection If the tax is not collectible from the trustee it may be collected from the settlor and from beneficiaries who received a distribution, limited to amount of distribution received. No tax relevance to trustee s residence The residence status of the trustee, even if it is in Israel, is tax neutral as far as Israeli tax is concerned. Corporate entities There are various rules regarding corporate settlors/beneficiaries: Settlement by corporate entity: Deemed a sale and the settled assets deemed a dividend distributed to the direct or indirect individual shareholders of the entity. Settlor includes: a person who was, directly or indirectly, a substantial shareholder in a corporate entity at the time the corporate entity transferred the asset to the trustee; a person who held, directly or indirectly, one or more of any type of means of control in a corporate entity, at the time the corporate entity transferred the asset to the trustee, and he, or his relative, is a beneficiary in the trust in question. Beneficiary includes: a person who holds, directly or indirectly, one or more of any type of means of control in a corporate entity beneficiary, which is not a public institution. Substantial shareholder one who holds 10% of the means of control. Means of control - the right to profits; the right to appoint a director or a general manager in a company, or similar functionaries in a different type of corporate entity; a voting right in a general assembly of a company, or in a similar organ in a different type of corporate entity; the right to a share in the remaining assets after payment of debts, at the time of liquidation; the right to direct a person holding any of the above rights how to exercise such right. Existing trusts The above rules apply as well to trusts created before January 1, 2006, save that tax will be imposed on such trusts if taxable under the above rules only from that date onward. Reporting The trustee must file an annual tax return (even if no tax is payable) in all the types of the trusts mentioned above. An Israeli resident who created a trust prior to January 1, 2006 and such trust is still in existence on that date must file a report giving full details of the trustee, beneficiaries, protector and assets settled (value and date of purchase). In general the following must file a similar report: settlor (or contributor) of a trust in any tax year (the text does not specify a resident settlor!); trustee of a trust created by an Israeli resident or if the trustee had income or an asset in Israel; beneficiary who received a distribution from a trustee even if it is not taxable.

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