How a UK Family Trust Resolved Israeli Tax on a Tel Aviv Rental

Result: Trust correctly classified so Israeli tax fell only on the Tel Aviv rent, the UK portfolio confirmed outside the Israeli net, and double taxation eliminated by treaty credit · Timeline: 6 months · Challenge: Whether an Israeli rental pulled a whole UK trust into Israeli tax · Authority: Israel Tax Authority · Financial Impact: Israeli tax limited to NIS 9,600 a year instead of an assessment on worldwide trust income

Background

The instruction came from a firm of solicitors in the English Midlands, on behalf of the trustees of a family trust. The settlor, a British businessman, had set the trust up years earlier for his children and grandchildren, all of them UK residents. Most of the trust's value sat in a UK investment portfolio, but tucked inside it was a two-bedroom apartment in north Tel Aviv that the settlor had bought on an old attachment to the city and then settled into the trust. The trustees let it out, and the rent, about NIS 96,000 a year, came in steadily.

For as long as anyone could remember, the trustees had declared that rent to HMRC as part of the trust's income and paid UK tax on it. They had never filed anything in Israel. The assumption, never tested, was that a UK trust with UK trustees and UK beneficiaries was a UK creature with no business reporting to a foreign tax authority. The question only surfaced when the trustees considered selling the apartment and an Israeli conveyancer asked, almost in passing, which track the trust had been using to report the rental income in Israel. The honest answer was none, and the trustees called us before the sale could go anywhere.

The Challenge

Two fears arrived together, and they pulled in opposite directions. The first was that by ignoring Israel for years the trust had built up an undisclosed liability and penalties on the rent. The second, and the one that genuinely worried the solicitors, was the reverse: that holding Israeli property through the trust had somehow dragged the trust's entire worldwide income, the large UK portfolio included, into the Israeli tax net. If that were right, the exposure would dwarf anything the apartment itself could justify.

The answer turns on how Israel classifies the trust. The trust chapter of the Income Tax Ordinance 1961 (Sections 75C to 75P), introduced in 2005 and reformed in 2014, sorts trusts into categories by the residence of the settlor and the beneficiaries. A trust whose settlor and beneficiaries are all foreign residents, a foreign-resident settlor trust (ne'emanut, trust), is taxed in Israel only on income produced in Israel. Its foreign-source income sits entirely outside Israeli tax. On that classification, the Tel Aviv rent was caught because it is Israeli-source, but the UK portfolio was not, because it is not. The trustees' larger fear was unfounded, provided the classification held.

The classification was not automatic, though. The reformed trust rules contain a trap that I always check before reassuring anyone: if even one beneficiary is an Israeli resident, the trust can be recast as an Israeli-resident beneficiary trust and exposed to Israeli tax on a far wider base. One of the grandchildren had spent time in Israel, and we needed to be certain of her status before we could give the trustees the answer they wanted.

In Practice: Under the trust chapter of the Income Tax Ordinance 1961 (Sections 75C to 75P), a trust with a foreign-resident settlor and foreign-resident beneficiaries is taxed in Israel only on Israeli-source income, so the Tel Aviv rent is caught but the UK portfolio is not. The trustee must register with the Israel Tax Authority and file an annual trust return. On annual residential rent of NIS 96,000, the 10 percent track under Section 122 of the Ordinance produced Israeli tax of NIS 9,600 a year, with no deductions and no need to open the trust's foreign accounts to Israeli scrutiny.

What We Did

We began with the beneficiary question, because the whole classification depended on it. We confirmed, with documentary evidence and a written analysis, that the grandchild who had spent time in Israel had not become an Israeli resident under the centre-of-life test, and that no other beneficiary was Israeli resident. That fixed the trust as a foreign-resident settlor trust and put the UK portfolio safely outside the Israeli net.

With the classification settled, we turned to the rent. We chose the 10 percent track under Section 122 of the Income Tax Ordinance for the residential letting, which taxes the gross rent at a flat 10 percent without deductions. For a non-resident structure this is usually the right call, because the full-exemption track that Israeli-resident landlords can use is not available here, and the marginal-rate track would have meant opening up far more of the trust's affairs for a modest gain. We then regularised the back years. Rather than wait for the Authority to find the gap on the eventual sale, we filed the outstanding returns and paid the tax due on the 10 percent basis, which kept exposure to interest and penalties to a minimum and gave the trustees a clean Israeli record to show a buyer.

Everything was handled remotely. The trustees never travelled to Israel. They signed the engagement and filing authorities in England, the documents were apostilled and translated where the Authority required it, and we registered the trustee with the Israel Tax Authority and filed on the trust's behalf. We worked alongside the trust's UK accountants throughout, because the Israeli filing and the UK trust return had to tell a consistent story and the credit on one side depended on the figures on the other.

In Practice: Had any beneficiary been an Israeli resident, the trust could have been recast as an Israeli-resident beneficiary trust and taxed on a much wider base, which is why the residence finding came first. The NIS 9,600 of annual Israeli tax on the rent is creditable against the UK trustees' liability on the same income under the UK-Israel double taxation convention, so the rent bears tax once, not twice. We set this out for the UK accountants so the credit was claimed correctly on the trust's return.

For the mechanics of how Israel taxes residential rent and the choice between tracks, our guide to Israeli rental income tax tracks for non-residents explains the options in detail.

The Outcome

The trustees got the certainty they needed. The trust was confirmed as a foreign-resident settlor trust, so the Israeli tax fell only on the Tel Aviv rent and the UK portfolio stayed entirely outside Israeli tax. The annual Israeli liability settled at NIS 9,600 on the 10 percent track, and the same tax was credited against the trust's UK liability under the treaty, so the rent was not taxed twice. The back years were regularised on the same basis, with interest kept small and no penalty dispute.

The clean Israeli record also unblocked the sale the trustees had been contemplating. A buyer's lawyer asking how the rental had been reported now gets a straightforward answer, and the trust can sell the apartment whenever it suits the family rather than scrambling to fix years of silence under the pressure of a closing date. The whole exercise, from first instruction to a regularised position, ran about six months.

We also used the moment to put the trust's acquisition record in order for the eventual sale. A disposal of the apartment will attract Israeli betterment tax (mas shevach) on the gain, calculated from the original purchase price, so we gathered the settlor's old purchase contract and the costs that can be deducted from the gain and held them on file. Doing that now, while the documents still exist, will spare the trustees a frantic reconstruction when a buyer is waiting and the betterment-tax clock is already running.

Key Takeaways

What this case illustrates for non-residents in similar situations:

1. Owning Israeli property through a foreign trust does not pull the trust's worldwide income into Israeli tax. A foreign-resident settlor trust is taxed in Israel only on its Israeli-source income, so a single rental does not endanger the foreign portfolio.
2. It works the other way too. A foreign trust is not invisible to Israel. Israeli-source rent is taxable here regardless of where the trustees and beneficiaries sit, and the obligation does not disappear because it was never noticed.
3. Check the beneficiaries before relying on any of this. A single Israeli-resident beneficiary can recast the trust into a category taxed on a far wider base, so residence has to be established, not assumed.
4. For residential rent in a non-resident structure, the 10 percent track under Section 122 is usually the efficient choice, because the resident-only exemption is unavailable and the marginal track exposes more than it saves.
5. Regularise before a sale, not during one. A clean Israeli filing record removes a buyer's objection and keeps interest and penalties small, while a gap discovered at closing forces a rushed and expensive fix.

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Facing a Similar Situation?

If a trust or company you are connected with holds Israeli property, the right classification decides whether Israeli tax touches one asset or the whole structure, and getting it settled early protects both the trust and any future sale.

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