Private and Public Endowment - A Review
What are the various types of endowments, for which purposes were they created and in what way should they be administered?
By Adv. Dov Kivlovitch
What is an endowment and what is the purpose of its creation?
An endowment is a legal institution (classified under the category of ‘trusts’) which serves to regulate, by law, the designation (endowment) of one or several assets or part thereof, including cash, by a private person (the “creator of the endowment”) to materialize personal family purposes (for certain beneficiaries - usually a family member or other relative) (a “private endowment”) or for the benefit of the public, most commonly for social/humanitarian purposes (a “public endowment”) such as charity, education, culture and assistance to others, for the benefit of specific types of vulnerable populations.
A private endowment has advantages in that it may circumvent restrictions set by Succession Law (the “heir following an heir” prohibition) regarding the transfer of assets and financial means to descendants of the heir under a will.
A public endowment has advantages and benefits in that it enables to choose the public purpose according to the wishes of the endower, and enables optimal control of the realization and management of the property for the chosen public purpose. Simultaneously, the endower can also perpetuate his name or the name of a relative or of another person. It is done properly and will last for a very long time.
Another advantage lies in the existence of certain tax exemptions when transferring and realizing the real estate property.
How is an endowment created?
An endowment is usually created by means of a written document – the “writ of endowment” wherein the creator of the endowment expresses his intent to create an endowment, and determines its purposes, its assets, and its terms and conditions. The writ usually includes the appointment of a person (the "trustee") whose task it is to fulfill the endowment’s purposes by managing its assets and its distribution and/or earnings. In some cases, a corporation, such as a nonprofit organization or even a company, may be appointed as a trustee.
A “writ of endowment” may also take the form of an agreement between the creator of an endowment and the trustee, which stipulates all the terms and conditions of the endowment.
If the designation of the property is to be realized after the death of the endower, the endowment is usually in the form of a will.
The writ of endowment must be signed before a notary unless the endowment is in the form of a written will.
Another way of creating an endowment is by means of a payment instruction under the Succession Law. These instructions are mainly given by way of determining the beneficiaries of a life insurance or the beneficiaries in the event of the death of a pension fund member. In such case, the instructions are formulated so that they create an endowment.
Creation of an endowment by the Court
It also is possible for the Court to declare the existence of an endowment considering a factual situation wherein the interested party has made an Application to the Court which proves the existence of an endowment.
The endowment is “created” upon transfer of property to the trustee appointed under the writ of endowment.
The trustee must agree to act as such. If his term of office has not started yet and/or if he does not agree to act as a trustee, or if the trustee is unable to perform his duties, the Court may appoint a temporary/permanent substitute trustee.
Management of the Endowment - Court Supervision
The Trust Law grants the Court extensive supervisory and intervention powers with respect to the endowment and its management;
The Court may give instructions and provide guidelines to the trustee or to the substitute trustee regarding the performance of his duties in the framework of the endowment, and even deviate, in certain cases, from the written provisions of the endowment. The Court may also intervene in appropriate cases and modify the provisions of the writ of endowment or the ways of realizing its purposes or even cancel the endowment if it deems it impossible to fulfill its purposes or if they already have been realized.
The trustee has a duty of trust towards the creator of the endowment (the endower) as well as towards the beneficiaries of the endowment and its earnings. He may resign from his position by means of a notification to whoever is authorized to appoint him and with the approval of additional trustees, if any, or, if he is a sole trustee, with the approval of the Court. The Court is also authorized to terminate his position.
The creator of the endowment and a third party (including donors) may at any time add assets to the assets of the endowment.
The private endowment as a means of circumventing the limitations of the Succession Law
According to the provisions of the Succession Law, the testator is restricted to bequeath assets to a “chain” of two beneficiaries only.
A person cannot determine in his will that he is leaving his property to his children and then to his grandchildren and thereafter to their offspring - as an inheritance of an "heir after heir." This restriction can be circumvented by establishing a private endowment in the will, according to which the private endowment is the beneficiary of the will, and the relatives are considered beneficiaries of the endowment as opposed to heirs. It also is possible to appoint, in a will, a particular heir or a corporation as a trustee for other heirs or descendants - who are the beneficiaries under the endowment, as well as provide an instruction in the trust to transfer the assets to an additional heir as trustee for others.
Thus, the testator may also leave broad discretion to the trustee regarding the ultimate beneficiary of the assets, since the first heir is only a trustee, as opposed to an heir to whom the assets have been transferred.
Public Endowment - Special Instructions and Regulations
Due to public interest in the activity and management of a public endowment, the legislature has enacted regulations on the endowment and on its managers, imposing supervision and an increased duty of reporting and transparency. An endowment must exist and be managed in public;
A trustee of a public endowment must, within three months from the day on which he becomes a trustee, notify the Registrar of Endowments (who is the relevant regulator at the Corporations Authority) of the existence of the public endowment, and attach to the notice a copy of the writ of endowment and the following details/modifications thereof:
(1) the name and address of the creator of the endowment;
(2) the date of commencement of the endowment;
(3) its purposes;
(4) its assets;
(5) the name and address of each trustee;
(6) other details prescribed by the Minister of Justice.
These details will be recorded and published in the Registry of Public Endowments. The Registry shall be open for inspection by the public; the Registrar shall also publish in the official gazette a notice of registration of the endowment.
A trustee of a public endowment must submit reports to the Registrar at the times and in the details prescribed by the Minister of Justice. The trustee must also provide to the Registrar, at his request, information and copies of documents in all matters relating to the endowment.
If the Registrar has reasonable grounds to fear that an endowment has not complied with a provision of the Trust Law or with the provisions of the writ of endowment, or that his reports to the Registrar are incomplete or incorrect, the Registrar may, on his own initiative or at the request of the Attorney General, investigate the public endowment, and he shall have extensive investigative powers, similar to those based on the Commissions of Inquiry Law, 5729-1968.
Taxation of the Public Endowment Regarding Transfers of Real Estate and Donations in General
The tax advantages of a public endowment recognized as a "public institution"
At prima facie, and according to the language of the Real Estate Tax Law, the creation of an endowment for a real estate property constitutes a “transaction in real estate”, since it transfers to the public of beneficiaries, by virtue of the endowment, a right in the real estate that derives from the very creation of the “connection to the property” between them and the real estate.
The transfer/endowment of the real estate by the endower is therefore considered, under the law, a “transaction” and a “purchase” of rights in real estate. The beneficiaries are thus considered “purchasers" with regard to such transaction (and are subject to purchase tax), whereas the creator of the endowment (the endower/donor) is considered a “purchaser” for purposes of the Land Taxation Law (and subject to betterment taxes).
However, pursuant to Section 61 (a) of the Real Estate Tax (Betterment, Sale and Acquisition) Law, 5723-1963, the sale of a right in real estate without consideration to a “public institution” is exempt from taxes (betterment taxes by the endower, and purchase taxes by the endowment). Nevertheless, the exemption is likely to be qualified and relative, as shall be explained below.
A “Public Institution” is defined in Section 61 (d) of the Real Estate Tax Law as: “institutions of religion, culture, education, science, health, welfare or sports or for any other public purposes not intended for profit, which were determined to that effect by the Minister of Finance with the approval of the Finance Committee of the Knesset.” Also, paragraph 61 (e) of that Law provides that: “a public institution established for purposes of Section 46 (a) of the Income Tax Ordinance shall be deemed to also have been determined for purposes of subsection (d).”
A “public institution” for purposes of exemptions under the Real Estate Tax Law is therefore an institution approved for purpose of crediting donations under Section 46 (a) of the Income Tax Ordinance or an institution specifically approved by the Minister of Finance for purposes of the Real Estate Tax Law.
The advantage of obtaining the status of “public institution” for purposes of a public endowment under Section 46 (a) of the Income Tax Ordinance does not only lie in obtaining an exemption under the Real Estate Tax Law but also in the right to allow the donors of the endowment to obtain a deduction for donations!
This is the advantage that can be leveraged in order to receive donations from commercial entities for purposes of the endowment, including assets (similar to a nonprofit organization/public benefit company).
What about the sale of real estate rights by the "public institution"?
Section 61 (c) of the Real Estate Tax Law provides that:
(a) In the event an institution has sold the right in real estate which acquisition was exempt from taxes under subsection (a) within five years from the date of purchase, the seller shall also be liable for taxes for which the person from whom the right was acquired was exempt under the provisions of said subsection.
In other words, when an endowment that has been recognized as a “public institution” receives a right in real estate, without consideration from the creator of the endowment, the creator of the endowment will be exempt from betterment taxes in respect of the transfer of said right in the real estate. However, if said endowment sells that same right within five years from the date of its receipt (i.e. the date of creation of the endowment), it will be liable for the betterment taxes that the creator of the endowment would have incurred if he had sold the right for full consideration.
Partial/Relative Exemption in the Framework of a Sale by the Endowment /Public Institution
Section 61 (b) of the Real Estate Tax Law provides an additional relative exemption of betterment taxes to apply to the sale of a right in land by a public institution, as defined in the Real Estate Tax Law: "...
1. If the land in which the right is sold was held by the institution for at least one year, and served the institution directly for at least 80% of the period during which the land was in its possession - it shall be exempt from taxes;
2. If the land in which a right therein is sold, has been directly used by the institution for less than 80% of the period during which the right in real estate was held by the institution, or was not used at all -
(a) Where the right to real estate was held by the institution for a period not less than one year and not more than four years, a relative tax exemption shall be granted, according to the ratio between the period during which the land was directly used by the institution and the entire period for which it held that right;
(b) Where the right to real estate was held by the institution for a period exceeding four years, an exemption of half of the taxes shall be granted, and if the real estate was directly used by the institution, an exemption of the proportionate part of the second half of the taxes, shall be granted in additional to the aforementioned exemption, corresponding to the ratio between the period in which the real estate was used directly by the institution and the entire period during which it held that right.”
Therefore, understanding the meaning of the term “and used directly by the institution” and understanding its interpretation by the Tax Authority and by the Courts is critical with regard to the exemption in the event of a sale of real estate by the endowment. This is a highly complex issue extensively dealt with in case law and which requires detailed planning and consultation.
In a nutshell, the rules determined for purposes thereof can be summarized, among others, as follows:
A. A condition for recognizing such "use" is that the property is used directly for a (declared and registered) public purpose of that endowment/public institution.
B. For purposes of “direct use”, physical contact and physical proximity between the property and the location of the institution it serves is necessary.
An endowment is a legal institution in trust is used for private or public purposes, and its advantages lies in the ability to circumvent the limitations of the Inheritance Law.
A public endowment is a legal institution which functions in addition or as an alternative to a nonprofit organization or a public purpose company, and which management may be easier and simpler since it is carried out by a trustee.
Therefore, when it comes to property/properties from which public purposes are to be financed, it may be preferable to create an endowment instead of establishing a nonprofit organization whose operation and management may complicate and raise the cost of implementing public goals. However, it should be borne in mind that a sole trustee of a public endowment has extensive duties and responsibilities, but is subject to limited supervision. It is therefore appropriate to appoint a suitable and experienced person to this position, and to set proper means of controlling his actions. It seems preferable to appoint a professional who will receive proper compensation for the performance of his duties.
It is also possible to use an existing/new organization/company as a "trustee" for the management of the public or “quasi endowment” endowment, but one should consider the advantages and disadvantages of this. The Memorandum of the Endowment Law provides that a public purpose company must be established in order to uphold the trustee institution.
An initial “rule of thumb” can be established whereby, insofar as the assets of the endowment are large/numerous, and ongoing supervision is required, it is preferable to appoint several trustees or to appoint a corporation acting as a trustee.