The Income Tax Ordinance includes a special purpose chapter on the taxation of trusts, which imposes tax and reporting duties on trusts, settlors and beneficiaries, and it includes beneficiaries and income into the Israeli tax net, which would be normally exempt from tax in Israel, were it not for the trust arrangement.

A tax ruling has been handed down recently, which determines that the trusts chapter will not apply to shares in a foreign company in the hands of an individual, which are held by him on behalf of an Israeli company. The following are the relevant facts regarding this tax ruling:

A.An Israeli company was engaged in systems development in the financial field.

B.The Israeli company established company Y in country Y, with which Israel has signed on a tax treaty (we would mention that company Y is an active company, which employs employees).

C.The Israeli company sought to provide services to local customers in country Z, however it requested that the shares in company Z, which will be established in country Z, will not be held by it directly but rather indirectly through Company Y.

D.The Israeli company is not interested in the customers in companies Z or Y knowing about its holdings in them, and therefore it transferred its holdings in shares in company Y to a resident of Israel, who has a foreign citizenship, who will hold the shares on their behalf, as a trustee.

E.The trustee has been registered as the holder of all the shares in Company Y and he will act in accordance with the Israeli company’s instructions. He is not entitled to exercise independent judgment. He does not benefit from the fruits of the holding in company Y (for example: dividends and interest or capital gain) and all the income from company Y will be transferred to the Israeli company and will be reported by it.

F.The Israeli company reports on the holding as the shareholder in company Y in its reports to the Tax Authority and in its financial statements.

The Israeli company requested that the trusts chapter, including the reporting duties for the trustee, to submit annual tax reports in Israel would not apply.

It is determined in the tax ruling that the trustee will be viewed as an agent and that the trusts chapter, including the reporting duties that apply to a trustee will not apply to the relationship between the Israeli company and the trustee (so long as the trustee is a resident of Israel), and that the Israeli company will be viewed as the owner of the shares in company Y, including the implications of the provisions of the Ordinance, insofar as they may apply, for example on the matter of a CFC (Controlled Foreign Corporation), and control and management rules.

Furthermore, the tax ruling restricts the credit for foreign tax, which the Israeli company can demand in Israel, as a result of the holding of shares in Company Y in the hands of the trustee to the tax rates that are determined in the tax treaty between the state of Israel and country Y. The significance of this provisions is, for example, that income from a dividend or interest from company Y in the trustee’s hands, or a capital gain (insofar as there is a right to tax in respect of this income in country Y) shall be subject to the taxes that apply pursuant to the provisions of the tax treaty with country Y, and if tax has been paid that is higher than such restriction as a result of the holding by the trustee (for example higher tax rates that apply to income of an individual as compared with a company), there is no credit available for this difference in Israel.

This decision joins a tax ruling that was handed down in 2016 in the Lerner ruling, in which the Court recognized a trust arrangement (although the intention was to an agency arrangement) for the purpose of the holding of the target company.

From our perspective, the recognition of an agency mechanism instead of a trust mechanism in the circumstances of the tax ruling will enable the Israeli company to report on dividend income from company Y or indirectly in concatenation from company Z, on a grossed-up dividend track (subject to compliance with the rest of the conditions that are determined in the Law), subject to the foreign tax credit restriction, which was determined in the tax ruling.

There may be cases in which the trust mechanism is preferable to the agency mechanism, in accordance with the circumstances of the case, which will enable the utilization of the full amount of the foreign tax (subject to the provisions of the ordinance) – for example, where it is not possible to implement the grossed-up dividend path as a result of the holding rate condition that has been set therein not being met.

The agency mechanism enables Israelis who operate outside of Israel to hold foreign assets by means of an agent, whilst being able to enjoy the fruits of the holding in the assets, and our perspective is that this will be in accordance with the circumstances and the nature of the agency.

In our opinion, it would also be appropriate to enable activity by means of an agency in the hands of companies that have an interest not to hold directly or to be identified as the owners of other assets (and not specifically a holding in shares in any foreign company), such as a real estate property or a bank account. This tax ruling is important, in our opinion and it gives additional expression to the Tax Authority’s position, pursuant to which the agency mechanism is possible and is recognized by the Tax Authority.