Tax Alert No. 5 - 15.7.2009

As we indicated in our Tax Alert No. 2 (August 25, 2008), the 147 Income Tax Ordinance Amendment has introduced a new tax regime of trusts into the Israeli tax law. Amendment 147 (effective date January 1, 2006) also imposed certain reporting requirements on trusts that were created prior to Amendments 147.  A detailed tax amendment (Amendment 168) that was issued on June 11, 2008 and its Regulations has changed the reporting requirement: it requires the trustee to provide certain information regarding the four kinds of trusts and in addition it replaces the reporting requirement with a mere formal notification to the Income Tax Authority (“ITA“).

Notification requirements in relation to the four kinds of trusts under the Israeli law include:

• An Israeli Residents Trust (IRT) – a trust in which the settlor is an Israeli resident: the settlor shall notify the ITA within 90 days of any trust creation, a transfer of asset / income from an asset to the trust. In addition, there is no reporting requirement in case of a trust created prior to January 1, 2006 ;
•  A Foreign Settlor Trust (FST) – in case of an immigration of the settlor to Israel, the settlor will have to report on this change of the trust classification to the ITA until April 30 of the following tax year; It should be noted that any change of a trust classification should be similarly reported.
•  A Foreign Resident Beneficiary Trust (FRBT) – where the beneficiary received a benefit in kind, he should  notify the ITA until April 30 of the following tax year;
• The Testamentary Trust (TT) – the trustee must notify the IRA within 90 days from the day the will’s provisions regarding the trust are effective;

Where a trust agreement of an IRT or TT  ceases to be effective, the trustee is required notify the ITA until April 30 of the following tax year.

Special notification requirements regarding trusts that were created prior to January 1, 2009:

The Amendment requires notification in relation to trusts that were created prior to the enactment of Amendment 147.  There were few postponements of the notification deadline (June 11, 2008, September 9, 2008) and the current deadline is October 31, 2009. This date also applies to tax filings (Section 131).  In addition, specific forms were published by the ITA. These forms are in both Hebrew and English. A set of formal rules was also published in order to elaborate the process of opening an  ITA File (with the relevant Tax Assessing Officer, mainly with Tax Assessing Officer Tel Aviv 1 or 3 that will be formally regarded as the Tax Assessors of Trusts).

Recently, the ITA has been “updating” old income tax treaties which were concluded by Israel in the sixties. The new treaties are based on the OECD Model Convention on Income and Capital. A new tax treaty with Germany was signed (with initials) and similarly the new tax treaty with the UK (April 2, 2009).

The full text of the treaties shall not be published before they are formally and fully signed and become effective. However, the Israeli Foreign ministry has issued a briefing regarding the UK – Israel treaty. This includes the following information:

Dividends – No withholding tax (“WHT“) on dividend distributions in case of a minimal (substantial) holding of 10% by the parent company and 5% in all other cases (instead of the 15% WHT);  No WHT will be imposed if the recipient is a pension fund. A new provision in Israeli tax treaties was firstly introduced in relation to REIT: a maximal WHT rate of 15% on payments from REIT’s if the recipient holds less then 10% interest in the distributing REIT.

Interest – the former 15% WHT rate is replaced with a maximal rate of 5% WHT. In addition, the taxpayer may elect to be taxes on the net interest income as business income. A WHT exemption is introduced with respect to certain interest transactions (e.g. payments to pension funds, interest on bonds).

Royalties – as in the OECD Model convention, no WHT will apply.

Capital gains – as a general rule, gains from the sale of shares would be subject to tax only in the residence state of the seller excluding: (i) shares in a real – estate company, where the value of the shares is mostly from real property and (ii) shares in a traded company, which is not classified as a REIT).

Trusts – the new treaty contains other changes, however, it is worth mentioning that a new innovative provision related to the taxation of trusts was introduced.  Trusts are included in the definition of “persons” under the new treaty and a special provision requires the contracting states to settle dual residency disputes in relation to trusts, while examining the residency of all the parties (settlor, beneficiaries and trustee).

Israeli VAT rate increase – Please be informed that the Israeli Minister of Finance has issued a formal Order, according to which the VAT rate will be increased to 16.5% (replacing the 15.5% rate), as a temporary provision, which is effective from July 1, 2009 and until December 31, 2010. The order was approved by the Israeli Knesset (the parliament) on June 29, 2009. As in the case of any indirect tax, this new rate may affect “end users” in relation to Israeli real estate transaction, the supply of goods and the provision of services.

As part of the global combat against harmful practices in the area of taxation, Israel has been joining the OECD efforts in this area. Following the OECD Convention on Combating Bribery and the OECD Report on the implementation of this Convention by Israel (March 19, 2009), a specific Draft Law Amendment 170 to the Income TAX Ordinance (“ITO”) was published on June 1, 2009. This Amendment is a complementary step to the Criminal Code amendment of 2008 that prohibits bribing a public servant and a recent landmark court decision that prevents the deductibility of illegal payments to foreign public servants.

According to the 170 Bill it would be prohibited under the Oredinance to deduct bribery expenses – whether they are cash or in kind expenses.  The actual wording of Amendment 170 refers to “payments, whether performed in cash or in kind, where there is a reasonable basis to assume that providing these payments constitutes an offence according to any law ” (free translation – O.R.). It may certainly be assumed that the phrase “any law” includes other jurisdictions, due to the fact that the explanatory text of the Draft Law discuss the global effect of bribery payments and the general and worldwide efforts to face this harmful phenomenon. This Amendment, if accepted, may provided the ITA with very wide discretion in classifying certain expenses as illegal per-se.