The air-condition in the car belonging to Mr. Naiveman, who is a veteran tax consultant, was indicating 16 degrees when he travelled to visit the assessing officer, and yet sweat was still dripping from his forehead. Going for meetings with Mr. Foxy, who was a mythological and cunning tax official, always made him feel pressurized. And you cannot blame him, Foxy always succeeded in raising an issue that Naiveman has not even thought of.

This time, however, Naiveman was slightly surer of himself. He went over the case one last time in his head, with considerable concentration (which almost cost an unlucky pedestrian his life): The trust was settled more than a decade beforehand by Yovav, Shimshon’s foreign resident father. Shimshon was both his client and a good friend who was the sole Israeli beneficiary from among five brothers, the rest of whom are foreign residents. The trust is a “relatives trust”, to the best of his understanding, which enables Shimshon to pay restricted tax at a rate of just 30% and only where he receives an actual distribution, however up to that time, he had not received anything. The only time that he had received money from the trust was about two and a half years ago. He had asked his father (who is one of the beneficiaries of the trust) for a loan of NIS 100,000 for the purpose of refurnishing his home, which he would repay when his Study Fund would be redeemed. This really was a clean story, Naiveman thought to himself, after all even Foxy’s ability is not unlimited.

The discussion was held in a good spirit, however, Foxy’s mischievous smile contributed nothing to Naiveman’s level of confidence. “What interest has Shimshon paid on the loan?” Foxy asked Naiveman, and he perceived that Naiveman had not prepared himself for this moment. “Interest? On what? All that happened was that the father gave his son a loan for a short period of time.”

“It’s written in the law”, Foxy replied nonchalantly, which shook Naiveman up slightly, however he made a quick recover: “I searched the entire Income Tax Ordinance, and I did not find any section that mandates interest on a loan within a family. And if you are talking about transfer pricing between a foreign resident and a resident of Israel, and I checked this myself and a trust of relatives is not deemed to be a foreign resident”.

“You’re a funny one”, replied Foxy, “Who is talking about the Ordinance? I am referring to the Income Tax Circular, on the subject of the Tax Authority’s interpretation of the trusts chapter, and this is what guides us. Regarding a loan, it is determined that the provisions of a loanto a beneficiary at a price that is lower than market price may be deemed to be a distribution at the level of the difference between the market price and the consideration that has been paid for it.

“So what’s the story?” replied Naiveman, who was quite calm, “how much can annual interest on an amount of NIS 100,000 be? Let’s assume its NIS 8,000? So come on let’s determine that it’s a distribution, we’ll pay tax and close the story out”.

“Just a moment, hold on”, replied Foxy, “I have not finished reading to you from the circular. So this is how it goes – A loan from the trust to a beneficiary… which has not been returned within 24 months may also be deemed to be a distribution at the level of the principle of the loan…”.

Naiveman had lost any appetite for fighting him: “Fine, I will speak with Shimshon and Yovev and tell them that you are insisting on taxing a distribution of NIS 100 thousand, it does not appear to me that they are going to argue about that”.

“Too late” replied Foxy, “The taxation of a distribution is not what I am interested in. After all, he has repaid the loan. So after we have agreed that the loan is essentially a distribution, so the repayment of the loan has to be a settlement!”

“Where are you going with this Foxy? The last time that I checked, a settlement in a trust is not a tax event” asked Naiveman, feeling (justifiably) worried about what the reply would be.

“That is indeed true” Foxy continued, “but whoever settles an amount in a trust is considered to be a settler, true? And if the settler is a resident of Israel, the trust cannot be a trust of relatives, you agree? And if it is not a trust of relatives, then it is chargeable with taxation on its income, isn’t that the case?”

“Oops, he did it again” Naiveman thought to himself, and admitted his defeat. At the end of the discussion and negotiations, it was agreed that the trustee would return the amount that had been repaid to Shimshon (“at least I achieved something for him” Naiveman thought), and in consideration, Foxy agreed to make do with taxing the amount of the distribution at a rate of 30% and not to claim that there was a change in the classification of the trust.

Naiveman checked the understanding that had been achieved with the trustee. “It’s strange” replied the trustee, “generally the risk when providing a loan is that it will not be returned. This is the first time that I encounter a situation in which the risk relates specifically to it being returned”, however in the end the trustee was convinced and agreed to return the money to Shimshon.

After a few days, Naiveman went back to Foxy’s office in order to sign on the agreement and to arrange the payment. Before leaving his room, he told him how he had got back to Shimshon, feeling bruised and battered (emotionally, of course) and how he had agreed to collect only half of his fee in order to pacify him, after all, they had been friends for many years.

“Only half?” said Foxy, “Are you aware that in that same circular it is determined regarding a settlement that the provision of a service to a trust at a price that is lower than market price, may also be deemed to be a settlement of “an asset” the value of which is the level of the difference between the market price of  the service that has been provided to the trustee and the consideration that has been paid for it”.

The above case is one of many examples of transactions that are connected to trusts and which may give rise to unnecessary tax implications, it is desirable and advisable to receive current advice before they are executed.