On July 24, 2019, judgment 49026-07-17 Samuel Galis Vs. Director of Land Appreciation Tax Tel-Aviv 1 (hereinafter: "The Galis Case") has been issued, whereby is was determined that the transfer of real estate into a trust will no longer be considered as a tax event, contrary to the Israeli Tax Authority's (ITA) position, as provided in section 13 of Circular 5/2016 regarding the Taxation of Trusts (the "Trusts Circular").
The Tel Aviv-Jaffa District Court, sitting as an Appeals Committee under the Real Estate Taxation Law (Appraisal and Acquisition), 1963 (hereinafter "RETL"), rejected the ITA's position and held that the arrangement stipulated in Chapter Four "B" of the Israeli Income Tax Ordinance [new version] 5721-1961 (ITO), which deals with trusts, regarding the transfer of real estate assets in Israel to a trustee, should be applied in accordance with section 3 of the RETL.
The appellants, Samuel and Ziza Galis (foreign residents), and Begin Trust 2015 Ltd (respectively: the "Settlores" and the "Trust", and together the "Appellants") created a Trust in Israel for the Settlors' granddaughter, an Israeli resident (the "Beneficiary"). The Settlors transferred four real estate assets in Israel into the Trust.
The main points of the trust agreement determined:
- The assets of the Settlors will be transferred to the trustee by irrevocable transfer;
- The trustee will act in the favor of the Beneficiary's interest, at his sole discretion and he will decide if and when to distribute the assets and the proceeds of the Trust to the Beneficiaries;
- The Beneficiary is not aware of the existence of the Trust, and that she is a beneficiary in it, and the Trust must be kept secret;
- The trustee shall be bound by the instructions of the protector, who was appointed in order to keep the interests of the Beneficiary (the "Protector"). According to the trust agreement, the Protector is authorized to dismiss the trustee and appoint a new one, and to add or remove beneficiaries - at the will of the Settlors.
The Settlors reported the transfer of rights in the assets to the trustee and declared it in a self-assessment for the Trust under sections 75C and 75G(d) of the ITO as a tax exempted grant. The Appellants took the position that under these sections transfer of real estate assets located in Israel into an Israeli Residents Trust, carried out without any consideration, shall not be deemed as a sale. In addition, and despite the fact that section 75G(d) states that such transfer shall not be deemed as sale for the purpose of the provisions of Part Five (capital gains) of the ITO, the Appellants' claim was, that land appreciation tax is a particular case of capital gains tax for Part Five's purposes, and therefore the transfer should be exempt of land appreciation tax under section 3 of the RETL, and acquisition tax under regulation 27 of the Real Estate Taxation Regulations (Appraisal and Acquisition)(Acquisition Tax), 5734-1974.
The parties disagreed whether the transfer of assets to the Trust in this case shall be considered as a sale to the trustee, or alternatively to Beneficiary in case the Trust is a Relatives Trust (ITA's position); Or, in light of the provisions of Chapter Four "B" of the ITO – there is no tax event, and the day of sale will be postponed until the day the trustee will sell the asset or transfer it to the Beneficiary (Appellant's position)?
The District Court held, in precedent, that section 3 of the RETL is not a negative arrangement, but is rather a lacuna and that the list of laws enumerated in section 3 (the list does not include the ITO), and which by their virtue a transfer of asset to a trustee shall not be deemed as a sale, is not a closed list and a later legislation (as Chapter Four "B" of the ITO) can be added into it. It should be noted that in a minority opinion, Judge Magen Altuvia thought the list of laws in section 3 of the RETL is a closed list (negative arrangement), and therefore the matter discussed in this appeal should be settled by express legislation and not in court. Notwithstanding, Judge Altuvia accepted the conclusion of the majority opinion, that in this case the transfer of Israeli real estate does not create a tax event, since the Trust is a revocable Trust, in which the Settlor can influence the trustee's actions through the Protector.
The meaning of this judgment, is that grant of real estate assets in Israel to an Israeli Residents Trust or to an Israeli Beneficiary Trust, shall not be deemed a tax event at the moment of transferring it to the trustee.
Although the result of the Galis Case is right, we believe the discussion regarding section 3 of the RETL was not required at all, since the Trust in this case is a revocable Trust – and this due to the existence of the Protector, which allows its Settlors to regain ownership of the Trust assets.
Therefore, whether we deal with Trust of Israel residents or Trust of Israel resident beneficiary (the correct classification in our view, since the Settlors are foreign residents and the beneficiary is an Israeli resident), according to section 75G of the ITO, the result could be reached regardless the applicability of section 3 of the RETL.
At the same time, the judgment did not deal with the entire wide consequences of it: for example, who is considered the owner of the assets, which were transferred to the trustee – the Trust/Trustee or the Settlor?
It should be noted that when it comes to residential apartments, the question of the seller's identity is critical, since it affects the tax to be paid on the sale, as well as the tax to be paid when purchasing additional apartments by the trustee and/or the Settlor. This Judgment also raises the question whether in similar cases in future, the transfer of asset from the trustee to the beneficiary shall be deemed as a direct transfer from a Settlor to a beneficiary under section 75G(f) of the ITO, and then personal exemptions as exemption from land appreciation tax and acquisition tax regarding a single apartment will apply; or whether it would be seen as a full transfer to a trustee, and then personal exemptions will not apply according to section 75F(f) of the ITO. In our view, a broad interpretation favoring the taxpayers, as the first option, should be adopted in this regard.
Furthermore: will the provisions of section 75G(f) of the ITO which state that at the event of distribution of the asset to the beneficiary, the Settlor shall be deemed as an Israeli resident even if at the moment of distribution, he is no longer an Israeli resident, will apply?
It is worth mentioning that Judge Altovia believed, that even if the transfer of the asset to the trustee is not a sale, the asset itself remains owned by the Settlor. This determination may open various tax planning arguing that the settlor can still argue for personal benefits.
In conclusion, we support the dismissal of the ITA's position as provided in section 13 of the Trusts Circular by District Court. We think that the ITA's position not only contradicts the purpose of the trust institution, but it also contradicts existing legal judgments of the Supreme Court. Thus, the Trusts Circular determines, that in case the identity of the beneficiary is known, the transfer of the asset would be taxed like it was transferred directly from the Settlor to the beneficiary, regardless of whether the beneficiary is aware of the existence of the Trust or expressly expressed his consent to receive the asset. In Judgment 3684/15 Estate of deceased Nadim Kamal Vs. Estate of deceased Anisa Nahas (published on Nevo, February 7th, 2017), the Supreme Court repeated the assertion, that "a gift ends with the it being granted by the giftor to the recipient, with agreement between them that the thing is given as a gift". As we know, a gift is a contract as any contract, and therefore the consent of the recipient is required for its existence (and in real estate, a deposition of the recipient that he agrees to accept it). Therefore, a gift transaction should not apply on an asset, and therefore purchase tax (even if partial) should not be charged, if the recipient did not give his consent to receive the asset. In our opinion, in the Galis Case, where the Beneficiary was unaware she is a beneficiary in a trust, and did not consent to receive the assets of the Settlors, a gift transaction has not been made, and certainly the Beneficiary could not be charged with purchase tax.
However and despite the justified result the District Court came with, the ITA does not appear to agree with the judgment in the Galis Case, according to which Chapter Four "B" of the ITO should be applied to section 3 of the RETL, and an appeal is likely to be filed soon.
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