The Tel Aviv District Court handed down a decision (July 2019) rejecting the Israel Tax Authority’s (ITA) position on the conveyance of real estate properties to trusts. This decision dramatically changes the taxation of trusts.

The decision involves Canadian residents who established a trust and holding company for the benefit of their granddaughter, an Israeli resident. The Canadian residents conveyed several real estate properties located in Israel to the trust without consideration.

The Canadian residents reported to the ITA the establishment of the trust and the underlying company (which was established only in order to hold trust assets and where the trustee holds all the company shares) as well as the transfer of the real estate in Israel to the underlying company. However, they claimed that this transfer does not trigger capital gains tax and not purchase tax under the Israeli Land Betterment Tax Law, because the trust is to be classified as an “Israeli Resident Trust” or an “Israeli Beneficiary Trust” and that according to para 75 c of the Israeli Income Tax Ordinance the conveyance of property to a trust is not a taxable transaction.

The ITA in contrast argued that for any real estate transaction in Israel the special Land Betterment Tax Law applies and takes precedence over the provisions of the taxation of trusts under the Income Tax Ordinance and that according to the Land Betterment Tax Law the transfer of Israeli real estate to a trust under a trust deed is considered a “sale” and therefore a taxable event on which capital gains tax and purchase tax is due.

The ITA issued a capital gains tax assessment on the transfer of the real estate properties into the trust. This assessment has been appealed by the Canadian settlors of the trust to the District Court in Tel Aviv. The District Court dismissed the ITA’s position that conveying Israeli real estate into a trust triggered a tax event.

The Court acknowledged that for the taxation of transactions in Israeli real estate, the special Land Betterment Tax Law applies and that in para 3 of the Land Betterment Tax Law only certain transfers of Israeli real estate to special trusts are not considered a “sale” in the meaning of the Land Betterment Tax Law. According to para 3 of the Land Betterment Tax Law certain transfers of Israeli real estate to special trusts or to the Administrator General are not considered a “sale” in the meaning of the Land Betterment Tax Law. In addition, according to para 69 and 74 of the Land Betterment Tax Law, the transfer of a Real Estate Property from the trustee to the beneficiary is not subject to capital gains tax provided that the trustee, very similar to an agent, purchased the real estate for the beneficiary and notified the tax authority of this purchase.

The Court then examined whether para 3 of the Land Betterment Tax Law, which contains a list of cases where Israeli real estate property is transferred to a person appointed by law in order to manage the property for the taxpayer, contains a closed list and whether para 3 could not be extended to other cases, such as the transfer of Israeli real estate to a trust established by a trust deed.

The court came to the conclusion that it is a closed list.

Then the Court further discussed whether para 3 of the Land Betterment Tax Law contains a negative arrangement, meaning that because para 3 does not mention the ordinary transfer of Israeli real estate into a trust according to a trust deed, the legislator’s intent was that such a transfer is a taxable event. The Land Betterment Tax Law has been enacted in 1963 whereas the trust law and the provisions for the taxation of trusts have been enacted only years later in 1979 and 2005 respectively, so that the legislator in 1963 could not have foreseen or intended to especially exclude the transfer of real estate into a trust according to a private trust deed as a non-taxable event.

Furthermore, the Court discussed whether the non-mentioning of Israeli real estate in para 75 c of the Income Tax Ordinance according to which the granting of assets into a trust is not a taxable event, means conversely that the transfer of Israeli real estate into a trust is a taxable event. The court said that there is no justification to treat assets such as real estate property located abroad or shares in an industrial enterprise different than a transfer of rights in an Israeli real estate property. The Court states that the non-mentioning of real estate in Section 75 c of the Income Tax Ordinance is a “lacuna” – a gap in the language – which does not imply the negative interpretation adopted by the tax authority. Rather, the Court has to fill the “lacuna” which is contained in the Land Betterment Tax Law with the principles of the special provisions for taxation of trusts as contained in the Income Tax Ordinance which override – in the opinion of the court – the general provisions in the Land Betterment Tax Law with respect to the granting of Israeli real estate to a trust.

The Court ruled that the transfer of rights in Israeli real estate into a trust is not considered a “sale” and there is not capital gains and purchase tax due at this point in time. Rather, the taxable event is postponed to the time when the trustee sells the asset or distributes it to the beneficiary.

In addition, the Court emphasized that not only the conveyance of a real estate property to a trustee does not constitute a taxable event but also the changing of the beneficiaries. This too, contradicts the ITA’s stated position.

This District Court decision dramatically alters the possibility to transfer Israeli real estate into an Israeli trust. It will be interesting to see whether the ITA appeals this decision to the Supreme Court (most likely) and, if so, how the Supreme Court will decide. The decision is not binding on other cases unless it is upheld by the Supreme Court.