1. Factual Background
1.1. "B" is an individual a resident of "Country X" and established there a manufacturing facility ("Facility").
1.2. Along the years, "B" and his wife ("Wife"; together "the Couple") began transferring funds out of "Country X" and, inter alia, established a trust in Europe ("Trust") with the assistance of a European lawyer ("Lawyer"). The beneficiaries of the Trust were the Couple and the Trust contained provisions designed to assist the Couples' family.
1.3. In the late 1970's members of the Couple’s family including the Wife immigrated to Israel. In the early 1980's the Facility was sold and the proceeds of the sale appertaining to "B" were transferred to the Trust whose assets grew and remained under the practical control of "B".
1.4. After the Couple passed away, two new trusts were established, one of them for the benefit of non-US family members ("NewT") and the second for the benefit of the U.S. family members ("UST"). The indenture of "NewT" was amended so that a beneficiary could not be either a U.S. or an Israeli resident. At that time, distributions were made so that in effect the entire corpus of "NewT" was distributed.
1.5. Each of the Beneficiaries of "NewT" established a wholly owned BVI company ("AboveCo”) and loaned the proceeds of the distribution to the said company which in return loaned the monies to "NewT". "NewT" established a BVI company ("UnderCo”) to which it loaned the funds it received from "AboveCos" and "UnderCo" invested the funds of "NewT".
1.6. Whenever withdrawals were made, the "UnderCo" repaid part of the loan to "NewT" who in return paid part of the loan to the "AboveCos" under consideration, who repaid the amount of the loan principal to the beneficiary under consideration.
2. The Issue
What is the status of "NewT" for purposes of Israeli taxation?
3.1.The relevant section regarding taxation of trusts in the Israeli Tax Ordinance ("Ordinance"), defines three classes of trusts: Israeli Residents' Trust ("IRT"), Foreign Settlor's Trust ("FST") and Foreign Beneficiary Trust ("FBT").
3.2. The classification as an FST or an FBT leads to no Israeli tax liability, assuming "NewT" has neither Israeli sourced income nor Israeli assets whereas the classification as an IRT leads to an Israeli tax liability on a worldwide basis.
3.3. Technically NewT does not come under the aegis of the FST definition. However, bearing in mind the special circumstances of the case under consideration, one could contend that for tax purposes, where the economic substance and not formalities matters, NewT is actually a reincarnation of the Trust settled by a non-Resident.
3.4. Bearing in mind the purpose of the new Israeli trust legislation, there should not be any difference in the tax treatment of NewT and it should be viewed for this purpose as if it was settled by a non Resident.
3.5. The tax opinion's conclusion was that there are good grounds for contending that NewT is an FST. This conclusion was reinforced by the analysis of the relevant sections in the Ordinance regarding the transfer of assets to a trustee of an FST and those dealing with a trustee according an asset to another trustee, as in the case under consideration.
3.6. As a fallback position our tax opinion concluded that one could contend that NewT is an FBT. In such a case, it will not be taxed in Israel on its non-Israeli sourced income.
3.7. The tax opinion provided a route of additional protection from Israeli tax liability with respect to Trusts whose Trustees’ are residents of countries that have signed a DTT with Israel.