Effective as of January 1, 2017: Significant Changes in Israeli Tax Law
With effect as of January 1, 2017 there are some significant changes in the field of Israeli taxation, which will have an influence for individuals, trusts and corporations. The Israeli corporate tax rate is reduced to 24 % as of January 1, 2017, whereas the surtax levied on high income individuals is increased to 3 % from 2 %. In addition there are some significant provisions enacted with respect to the taxation of cash withdrawals or the use of corporate assets by substantive shareholders. Furthermore, the new law contains a provision for the taxation pertaining to so called “wallet companies”, companies owned by individuals who provide services, and finally a beneficial temporary order with a reduced tax rate for dividend distributions, which will be made until September 30, 2017.
Decreased Corporate Tax Rate: 24 %
After the Israeli corporate tax rate has been reduced from 26.5 % to 25 % effective as of January 1, 2016, the rate will be reduced further in two stages. Effective as of January 1, 2017 the Israeli corporate tax rate is 24 % and will be 23 % as of January 1, 2018. In addition, under the reform of the Encouragement of Capital Investment Law, the corporate tax rate have been further reduced for Israeli Technology and High Tech Companies (see below).
Increase of Surtax (Mass Yessef): 3 %
With respect to the income tax of individuals the surtax levied on high income of individuals and trusts has been increased from 2 % to 3 % as of January 1, 2017. In addition, the surtax will be levied on a total annual amount of income and capital gain that exceed NIS 640,000 instead of the current amount of NIS 810,720.
As a result the tax rate for high income individuals, including payments for social security, can amount to about 59 % to 60 %.
Temporary Order with respect to Distribution of Dividends at Reduced Tax Rates
According to a Temporary Order effective as of January 1, 2017 the distribution of dividends by a company to a substantive shareholder (in general a shareholder who holds 10 % or more of the shares of the company) from profits accumulated until December 31, 2016 is subject to a reduced tax rate of 25 %, instead of the commonly applicable tax rate of 30 %. In addition, there is no surtax of 3 % applicable and the amount of the preferred dividends is not taken into account to compute the surtax of the substantive shareholder with respect to his other income. This preferential tax treatment for dividend distributions is only applicable if the distribution is made between January 2017 until September 30, 2017 and out of profits accumulated until December 31, 2016. A further requirement is that in the three year period after the distribution, between 2017 and 2019, the substantial shareholder does not receive a reduced amount in salary, management fees or interest payments compared to the average amount received in 2015 and 2016. Every taxpayer should examine whether he can take advantage of this beneficial tax treatment for dividend distributions according to the Temporary Order.
Taxation of Cash Withdrawals by Substantial Shareholders
Israeli corporate taxation is based on the principle of the “two stage taxation”. From a tax perspective this two stage taxation can be an advantage, especially in the light of the possibility to control the second stage of taxation, meaning when the distribution to the shareholder will be performed. Sometimes this control is exploited disproportionally by the corporations. The new rules give the tax authority some tools to deal with this tax planning scheme.
For example, substantial shareholders often withdraw cash funds from the company and only return these amounts after a period of time, if at all. The tax on deemed interest does not amount to the tax as if dividends have been distributed.
According to a new provision in the Israeli Income Tax Ordinance these cash withdrawals by substantial shareholders (in general a shareholder who holds 10 % or more of the shares of the company) are considered as income of the shareholder subject to Israeli tax no matter whether the withdrawal is characterized as loan or guarantee. Depending on the circumstances, these income items will be taxed as business income, salary, as dividend or as other income. The provision will not apply where the funds withdrawn are repaid to the company by the end of the tax year following the tax year in which the withdrawal has been made. The new provision is quite broad and includes any withdrawal of more than NIS 100,000, including shareholder loans and in certain cases also the mere guarantee by the company for a loan of the shareholder. This provision might even apply to loans between companies, unless the loan is between non-transparent companies based on a real economic purpose.
According to a transitional provision, the new rule with respect to taxation of cash withdrawals will not apply to withdrawals that have been made by December 2016 and will be repaid by December 2017.
Taxation of Use of Assets by Substantial Shareholder
With respect to the use of corporate assets by a substantive shareholder, the shareholder will be taxed according to the new provision as if he has received a dividend in the amount of the costs of the assets. In cases, where the company does not have retained earnings according to the corporate law, the income item will be characterized as salary or other income depending on the circumstances. This new provision definitely intends to make clear that for tax purposes there is a complete separateness between the assets of the corporation and those of the substantive shareholder. Substantives shareholders will be taxed on the costs of the assets if they use corporate assets like, real estate, art works, jewellery, aircraft and yachts for personal purposes in the future. The scope of the application of this new taxation rule is very broad.
If the substantial shareholder uses real estate of the corporation a transitional rule provides that there will be no taxation of income in the amount of capital gain for the substantive shareholder, if he returns the real estate by December 31, 2018.
New Rule for so the called “Wallet” Company
This provision is aimed at taxing individuals directly who are in essence employees, officers or directors however provide their services through privately held minority companies (commonly known as “wallet companies”. The reason why individuals use these so called wallet companies is that the tax rate for corporation is less than the tax to be paid by the individual for high salaries. The two stage taxation of companies has been disproportionately exploited in the past. According to the new provision the income of the minority company derived by the services of the individual is directly attributed to the individual and subject to the individual’s marginal tax rates up to 50 % instead of the reduced corporate tax rate of 24 % as of January 1, 2017. The Law thereby basically distinguishes between two situations. In the first scenario, an individual in a minority company is also officer or director in another company, which pays the minority company for the services rendered by the individual. Here the income of the minority company is attributed directly to the individual as salary, business income or other income according to the circumstances. The second scenario refers to a minority company whose income is derived by services rendered by individuals to another person or related person of the individuals and at least 70 % of the income of the minority company is derived from these services, and these services have been rendered for a period of at least 30 months within a period of 4 years. The new provision for the so called wallet companies does not apply if the minority company has at least for employees and not for the services provided by a partner to the partnership.
Power of the Tax Authority to Enforce Certain Companies to Distribute Profits (Dividends)
Under specific circumstances a new provision provides the Israeli Tax Authority with the power, subject to the consent of a special public committee and after giving the company the right to be heard, to demand that ” Minority companies” (generally companies that are controlled by 5 individuals or less) distribute dividends to their shareholders. The New Rule focuses on minority companies which accumulate their income without investing it for business purposes. The power of the Israeli Tax Authorities to demand distribution of dividends is limited to minority companies, which has not distributed at least 50 % of its profits in a specific tax year from profits accrued more than 5 years before the power is exercised and the retained earning exceed more than NIS 5 million. In addition the tax authority cannot demand the distribution if the money is used for business purposes and if the distribution results in retained earnings of an amount less than NIS 3 million.
Each taxpayer should examine the status of his retained earnings in order to examine whether this new amendment is applicable in his circumstances.
Corporate Tax Rates of 12 % / 6 % for High Tech Companies
In order to encourage even more the Israeli high tech industry, the new law provides for reduced corporate tax rate of 12 % or even 7.5 % (in preferential geographic areas) to Israeli Technology and High Tech Companies which develop their intellectual property in Israel ( see already Newsletter, …..In cases of a Special Preferred Technology Enterprise, where the consolidated turnover of the group is more than NIS 10 billion, the corporate tax rate is reduced to 6 %. In addition to the beneficial corporate tax rates, the withholding tax on dividend payments to shareholders will be 20 % and in case dividends are paid to a foreign company even 4 % if certain requirements are met. In order to receive these benefits certain strict conditions have to be met in order to ensure that the IP is developed in Israel.
These changes in the field of Israeli taxation effective as of January 1, 2017, are significant for individuals, trusts and corporations. Each taxpayer should examine his tax position and the impact of these changes. Especially minority companies, companies with not more than 5 shareholders, and their substantive shareholders should carefully examine whether the changes might have tax consequences for them and act accordingly in the year 2017.