Asset Distribution Between Heirs – What Comes Last Should Be Planned First
As is well known, inheriting assets is not considered a tax event according to the provisions of the Income Tax Ordinance and the Real Estate Taxation Law. But, what law applies when the heirs wish to distribute the estate’s assets amongst themselves in a manner that differs from what the will stipulates?
Taxation of the distribution of an estate’s assets between heirs is regulated in Section 5(c)(4) of the Real Estate Taxation Law. The aforementioned section stipulates that the heirs can distribute land assets in Israel that are part of the estate in a manner different from the will, and taxes will still not apply under the Real Estate Taxation Law, provided two conditions are met: 1. This is the first distribution of the estate assets among the heirs; 2. Within the distribution no consideration in cash or cash equivalent, which is not an asset counted among the estate’s assets, was received. If a consideration was received outside of the estate’s assets, only this consideration would be taxable.
The Income Tax Ordinance stipulates that inheritance is not a tax event but does not include a provision similar to the provision stipulated in Section 5(c)(4) of the Real Estate Taxation Law, which enables heirs to distribute the assets in a manner different from the will, without this constituting a tax event. Therefore, on the surface of things, a situation in which two brothers inherited shares in two companies, such that each of them received 50% of the shares in each of the companies, but the brothers wish for each of them to receive 100% of the shares of one of the companies, it would seem that such a distribution could be considered a taxable “sale” according to the provisions of the Ordinance. In our opinion, based on the Inheritance Law, tax rulings and caselaw, an interpretation can be adopted that a rule similar to the provision set forth in the Real Estate Taxation Law can also be applied to a “first distribution” of assets subject to the provisions of the Ordinance (such as shares).
Firstly, Section 110 of the Inheritance Law, and the caselaw on the topic, set forth that preference should be granted to distribution of the estate assets according to an agreement between the heirs over the stipulations of the will. Thus, in our opinion, the assets transferred according to Section 110 of the Law should be viewed as being excluded from the definition of sale in the Income Tax Ordinance.
As reinforcement for this argument, Tax Ruling 43/08 addressed the question of whether a first distribution of estate assets between heirs, which included land rights in Israel and additional assets (shares and various financial assets), was a tax event according to the Real Estate Taxation Law or the Income Tax Ordinance. Since, until the date of filing the request to receive a tax ruling on the matter, no act or distribution has been executed with respect to the estate’s assets or funds, and within the above distribution no consideration was paid in cash or cash equivalent which was not an asset included among the estate assets, it was concluded that distribution of the estate’s assets would not be considered a tax event according to the Real Estate Taxation Law and according to the Income Tax Ordinance (subject to several additional “technical” conditions).
In addition, in the decision Tulchinsky Israela v. Haifa Assessment Officer, the court addressed, inter alia, the tax implications stemming from the distribution of estate assets between heirs according to the distribution agreement. In the circumstances of the decision, in 1995, immediately before the date of the deceased’s passing, a succession order was granted regarding his assets, which included land in Israel and additional assets. The succession order stipulated an equal distribution of the estate’s assets among the heirs. About seven years later, the testator’s will was discovered, which had been made back in 1993, and which stipulated a different distribution of the estate’s assets between the heirs. The testator’s daughter initiated proceedings to issue a probate order for the will from 1993. After several legal negotiations, the heirs reached a settlement arrangement regarding the distribution of the estate’s assets, and the question arose whether distribution of the estate’s assets according to the settlement arrangement was taxable. The honorable Judge Wasserkrug concluded that the provisions of the Real Estate Taxation Law can also be exercised with respect to the distribution of assets between heirs, which are not land assets in Israel.
In this context, it is also worth mentioning Tax Ruling 7681/14, which dealt with the question whether the transfer of shares between spouses within a divorce agreement constitutes a tax event. Section 4A of the Real Estate Taxation Law stipulates that the transfer of land assets in Israel within a divorce does not constitute a tax event. In contrast, there is no similar provision in the Income Tax Ordinance, such that the transfer of assets between spouses within a divorce could be considered a taxable “sale”. This tax ruling also syllogized from the Real Estate Taxation Law for interpretation of the Ordinance, and concluded that the transfer of shares between spouses within a divorce agreement would not be considered a tax event (subject to several additional “technical” conditions).
In light of the above, it is possible to consider how to distribute estate assets between heirs, even where assets subject to the provisions of the Ordinance are concerned. Thus, for example, it is possible to consider if the heirs have losses that can be offset against future income to be received from the estate assets, or if there are Foreign Residents, New Immigrants or Returning Residents among the heirs, etc.
For additional information, contact Adv. (CPA) Shahar Strauss or Adv. (CPA) Tal Teri from our firm.
This memo’s objective is to inform you of general information on various topics. The law’s provisions themselves are more complicated and include additional exceptions. Accordingly, the foregoing in this memo should not be implemented without consulting the relevant professional.
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