Ronen Perry (Haifa; Google Scholar), The Tax Trap of Israeli Mutual Funds

One of the most troubling phenomena for Israeli retail investors is the tax trap that domestic investment companies regularly set for them. The problem can be described in a nutshell as follows: An investment company establishes a new mutual fund for investment in a particular sector with negligible (or even zero) management fees or significantly reduces the management fees of an existing fund. The low management fees entice many investors to purchase and accumulate the fund's units. After a while, when the investment has yielded a good return, the management fees are sharply increased without any substantive justification.

At this point, the investor is faced with an unpleasant choice: to keep holding the fund's units and pay the increased management fees or to get rid of them and immediately pay a hefty capital gains tax. Investors who have accumulated a significant return will generally prefer to continue holding the units in order to avoid an immediate tax and will, therefore, find themselves trapped in a much less lucrative investment with an increasing effect on the investment portfolio's return. Such a trap only tightens over time. This essay seeks to determine the severity of the problem and examine various models for its resolution, ultimately advocating a modest tax reform.

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