The chapter on trusts in the Income Tax Ordinance includes the following provision to avoid tax planning: A company that has assets, creates a trust, the beneficiaries in which are the controlling interests in the company, the company transfers assets to the trust, which will transfer them to those same controlling interests in the future (the beneficiaries in the trust), whilst raising claims regarding the absence of a tax charge.
Such planning might have been realized in light of the fact that most of the cases of the creation of a trust and the transfer of assets to it do not constitute a tax event and that is also the case in respect of most of the distributions of assets from trusts to beneficiaries. We have intentionally not related to “corners” and exceptions to the said principles.
The law determines that in a case in which a company transfers assets to a trustee, two events will occur:
The company will be deemed to have transferred the assets as if it had sold them – and then a capital gain may arise in the hands of the company.
The asset that has been settled in the trust is deemed to have been the distribution of a dividend to the individual shareholders (directly or indirectly) in that company.
:Clarifications and tax implications
• Relating to a company – It should be noted that the said provision related to every “body of persons” and not just to a company. This term is much broader and therefore there are significances for the application of the provision.
• Distinction between an “agency” and a trust – a distinction must be made between a situation in which a company transfers assets to a third party in order for it to hold those assets for it, this situation generally does not create a “trust” since the asset, the rights and the obligations therein, the revenues and etcetera belong to the owners. In this case, what is under discussion is an “agency” (or fiduciary). In such a situation, it should be noted that the agreement must reflect the existence of that agency and it is also appropriate that its heading should be “agency agreement” and not “trust agreement”.
• A sale to a trust other than at market price – we would say to a smart planner, who seeks to by-pass the provision by executing a “sale” of the asset to a trust, that the sale must be made at the market price! A sale other than at market price may be deemed to be a “contribution” into a trust to which the provision in the preceding paragraph applies, which is in light of a possible interpretation, pursuant to which the difference between the market price and the actual selling price meets the definition of a “contribution”.
• What is an asset? – We would emphasize that “an asset” is any asset within the broad definition of that term, including real estate rights in Israel.
• The new cost price of the asset – the price that has been set as the selling price, which is equivalent to the amount of the dividend that has been determined by the shareholders and it is appropriate that is should constitute the “cost price” in the hands of the those shareholders.
• “Tax mishaps” – over the years, we have encountered incorrect application, such as a case in which an Israeli company creates a significant agency arrangement on the transfer of an asset to a separate company, but has reported, in good faith and without having conducted an in-depth exanimation of the situation, on the creation of the arrangement as the creation of a trust, including the filling in and submission of the designated forms that have been published in relation to trusts (which is something that has resulted in the opening of a trust file and etcetera).