How is a trust taxed in Israel when all the beneficiaries live abroad?

Israeli trust taxation ignores what the trust deed calls itself. Chapter Four B of the Income Tax Ordinance 1961, introduced in 2005 and rebuilt by Amendment 197 with effect from 2014, sorts every trust into a statutory category based on who created it and who benefits from it, and the category decides the tax. A family that has never set foot in an Israeli tax office can find its Jersey or Delaware trust sitting squarely inside that chapter because one asset, or one beneficiary, has an Israeli connection.

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Detailed Answer

The category that matters most to families entirely outside Israel is the foreign residents' trust under Section 75I. It applies where, in the tax year, all the settlors and all the beneficiaries are foreign residents, and also where all the settlors have died, all the beneficiaries are foreign residents, and there was never an Israeli beneficiary. Such a trust is treated as a foreign resident in its own right, which means Israel taxes it only on Israeli-source income and leaves its worldwide income alone. Section 75J covers the mirror case, a trust settled by an Israeli resident whose beneficiaries are all foreign residents, where foreign-source income can escape Israeli tax provided the trust is irrevocable and Israeli residents are genuinely excluded from benefit. Section 75G sits at the other end: an Israeli residents' trust is taxed on worldwide income, generally as if the income were the settlor's. Two features of this scheme cause most of the damage. Classification is tested annually rather than fixed at creation, and a beneficiary who makes aliyah, marries into Israel or is simply born to an Israeli-resident parent can reclassify a trust that has been quietly compliant for a decade.

Israeli-source income remains taxable in every category, and this is where trustees abroad usually discover they have an Israeli footprint. Rent from an Israeli apartment held in trust is Israeli-source and can go on the flat 10% residential track under Section 122 of the Ordinance. A disposal of Israeli real estate by the trust falls under the Real Estate Taxation Law 1963, with the usual withholding and clearance machinery. Dividends from an Israeli company are subject to Israeli withholding at 25% or 30%, reduced where a treaty applies. Practically, the trustee needs an Israeli tax file, an Israeli representative able to sign filings, and answers ready for the compliance questions Israeli banks ask about beneficial owners under anti-money-laundering rules, which are asked of the trustee rather than of the beneficiaries. Families who use a US revocable trust for probate avoidance should read our answer on whether a US living trust keeps Israeli assets out of probate, because the succession answer and the tax answer point in different directions.

In Practice: Under Section 75I of the Income Tax Ordinance 1961 a trust whose settlors and beneficiaries are all foreign residents is treated as a foreign resident and taxed in Israel only on Israeli-source income, while Section 75J gives comparable relief to a foreign resident beneficiary trust that is irrevocable. Classification is retested each tax year by the Israel Tax Authority (Rashut HaMisim), so a single Israeli-resident beneficiary can convert the trust into a Section 75G Israeli residents' trust taxable on worldwide income. Israeli-source income survives the exemption regardless: an apartment held in trust and let for NIS 9,000 a month carries flat 10% tax under Section 122, NIS 10,800 for the year, payable by 30 January following the tax year. Opening a trustee tax file and registering an Israeli representative usually takes four to eight weeks.

When to Consult a Lawyer

• A beneficiary has moved to Israel, or is about to. The reclassification is automatic and retrospective within the tax year, and the planning that mitigates it has to happen before the move rather than after the first Israeli tax return.
• The trust holds Israeli real estate. Sales trigger the Real Estate Taxation Law machinery including withholding at source, and a trustee without an Israeli tax file cannot obtain the clearance certificates a buyer's lawyer will demand.
• The trust was set up before 2014 and has never been reviewed. Amendment 197 changed the categories and the reporting rules substantially, and structures that were compliant under the original 2006 regime are not automatically compliant now.

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Speak With an Israeli Attorney

An Israeli tax lawyer can classify the trust under Chapter Four B, work out exactly which income Israel can reach, and put the trustee's Israeli filings in place before a beneficiary's move forces the issue.

Contact us for a confidential initial consultation.