As Australian Jews, we love both our ancient homeland Israel and our resident country Australia. However, the taxation systems of these countries are not aligned and the integration between them can cause some unintended consequences that one needs to consider; none more so than the taxation of Australian tax resident family (discretionary) trusts with potential eligible beneficiaries being people living in Israel.
In Australia, if a family trust generates income, the trustee can resolve to distribute income to any eligible beneficiary. The recipient beneficiary pays tax in Australia on the distribution. If that beneficiary is an overseas person and a double taxation treaty exists with that other country, the higher taxation between the two countries is generally paid.
The Israeli legal system is based on common law with a mix of British, Turkish, Judaic law with influences from America and Canada. However, trusts that may be common in the US, Australia and other Commonwealth countries are a foreign concept in Israel.
The Israeli Government were concerned that income generated by trusts foreign to Israel (in particular US trusts), were generating no tax revenue for Israel, despite beneficiaries being resident in Israel and, possibly, dual citizens with another country. Israel decided to introduce a law which taxed the income of foreign trusts so that all income generated by that foreign trust is taxable in Israel, even if the Israeli beneficiary receives no income.
In Australia, the beneficiary receiving income is taxed. Most often all income is distributed to beneficiaries because, if not, the highest marginal rate of tax is paid. In Israel the trust itself is taxed although the Israeli law does allow for an election to be made where the Israeli beneficiary can be taxed on income he or she receives in the range 25% to 50%, depending on the type of asset held by the trust. The Israeli beneficiary may also be taxed in Australia at marginal rates and the 2019 Australia/Israel double Tax Treaty may give some relief to that beneficiary but the higher rate of tax applies.
But what if the trustee does not want income to be distributed to the Israeli resident? The trust is taxed in Israel on all income and those receiving income in Australia pay Australian tax on the income they receive. A tax disaster.
Because trusts are not common in Israel and the concept of private binding tax rulings are rare under Israeli law, and expensive and time consuming to obtain, most disputes are solved by negotiation by Israeli lawyers and accountants with the Israeli Taxation Authority (ITA), which leaves Australian advisers unable to provide clear advice to their clients on this topic.
It is well known that Israel provides a 10-year tax holiday for new Olim (immigrants moving to Israel and making Aliya). If distributions are made to an Israeli resident beneficiary of an Australian discretionary trust in the 10-year period, no Israeli tax would be paid by that Israeli resident, but they are still taxed in Australia. The information we have is that trusts will not be taxed by the ITA in that 10-year period.
How will the ITA know about the Australian/Israeli resident beneficiary if no distributions are made tothe Israeli?
I was asked this question many years ago about Australians who were also US citizens – how will they know about me? The double tax treaty with the US made it clear there had to be information flow between the two countries, particularly the banks. You may notice a question in the form opening a bank account in Australia – are you a US Citizen? That flow of information now applies to Israel and Australia following the 2019 double tax treaty between the two countries.
As no clear guidance is available from ITA, we presume that the worst possible outcome is likely and consider that all income generated by the Australian discretionary trust (or Australian testamentary trust in a Will) is taxable in Israel if an Israeli resident beneficiary is an eligible beneficiary.
One solution may be an amendment to the Australian trust deed excluding the Israeli resident from being an eligible beneficiary of the Australian family trust. There is discussion among colleagues that the timing of the amendment is critical. The exclusion of a child may be seen as unfair, as other non- Israeli children may get an advantage.
Each case should be considered individually based on available family assets and structures. Some clients seek to compensate an Israeli resident child through other means to achieve equality. In these circumstances, the skill of the Australian and Israeli accounting, taxation and legal advisers is important.
In the context of a Will, it may be feasible to have separate testamentary trusts for each child with the Israeli resident being excluded from the testamentary trusts of the non-Israeli resident children.
DISCLAIMER: The purpose of this article is not to provide advice to the reader (as every case is different) or to address the many issues, complexities, consequences and solutions that may arise but to make people aware of an issue and encourage them to seek appropriate legal, taxation and accounting advice pertinent to their own situation.
SPECIAL OFFER: The Moriah Foundation has a program where any person wishing to make a donation to the Foundation in their Will is entitled to a one-hour free consultation with a group of advisers who specialise in the area of Wills and Trusts.
Michael Henley Partner HWL Ebsworth and Accredited Specialist Wills and Estates