Your Taxes: It might be time to take your dividends

Shareholders of some Israeli companies can enjoy a reduced tax rate if they act in time.

By LEON HARRIS
Shareholders of certain Israeli companies may want to take their dividends by September 30, 2010, to enjoy a reduced tax rate of 12 percent, pursuant to special regulations that expire on that date. The regulations were introduced at the time of the creditcrunch crisis and were intended to stimulate economic activity.
The 12% tax rate only applies to profits generated by those companies in the years 1996-2002. This compares well with the usual Israeli tax rates for dividends: 25% tax for major shareholders who hold 10% or more of the company concerned; 20% tax for other shareholders.
(Different tax rates apply to foreign shareholders under some of Israel’s tax treaties and dividends paid by an approved or privileged enterprise under the Law for the Encouragement of Capital Investments, 1959).
12% DIVIDEND TAX RATE A number of conditions must be met regarding “preferred dividends” taxed at the 12% rate.
• First, the preferred-dividend recipient must be an individual or a company that has elected to be a “family company” (i.e., the main shareholder elects to be taxed instead of the company).
Nevertheless, the Israel Tax Authority (ITA) has indicated that in certain cases it will allow the 12% tax rate if an individual or family company receive the dividend via an intermediate holding company.
• Second, the preferred dividend is received in the period from October 1, 2009, to September 30, 2010. The dividend must be paid to the shareholder. According to instructions issued by the ITA, in cases of uncertainty, the dividend must not be offset against shareholders’ loans granted before 2006.
• Third, as mentioned, the preferred dividend must be paid out of undistributed profits generated in the years 1996-2002 only. The reason for this restrictive condition was never clear.
• Fourth, the relevant shares were acquired before January 1, 2002.
• Fifth, a minimum-income test must be met by the shareholders to ensure they don’t substitute preferred dividends for other income, such as salary, management fees, loan interest or loan indexation.
Total income received by shareholders from the dividend-distributing company in each of the years from 2009-2012 (“the tested years”) must not be less than the average income they received in 2007-2008, directly or indirectly, excluding dividends and the preferred dividend.
The ITA has clarified that the above testing will not apply to years the company is in liquidation, nor regarding years the recipient ceased to be a shareholder (e.g., due to death).
The Assessing Officer will check for compliance with the above for each year tested; if he is not satisfied, he may issue a 20%-25% tax assessment retroactively to the year the dividend was distributed. If only one shareholder fails the minimum income test, that shareholder alone will face a 20%-25% tax assessment.
Nevertheless, when the dividend is paid and tax is withheld, each shareholder will need to declare that he meets the minimum income test.
What happens if there is a drop in company profits that hampers its ability to keep paying income to the shareholder? If there is an exceptional drop in the company’s income due to circumstances not dependent on the company, the ITA may apply some latitude to the above test. It may also apply latitude to dividends from a group of companies where it is unclear which profits are being distributed.
To sum up, the 12% dividend tax rate was a nice idea for stimulating the Israeli economy. Unfortunately, it is hedged with numerous conditions and the penalty for getting it wrong could be 25% tax retroactively.
As always, consult experienced tax advisors in each country at an early stage in specific cases.
leon@hcat.co Leon Harris is an international tax specialist at Harris Consulting & Tax Ltd.