US tax form (illustrative).
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As part of the Israeli budget law for 2017-18, the tax on dividends paid by companies to material shareholders was reduced to 25% in certain circumstances. But the deadline for doing so is October 1, 2017.
The dividend tax change accompanies other new rules against “wallet companies,” also known as “cash box companies,” which retain profits to save tax.
Below is an overview of the new dividend tax rules in Section 125B of the Income Tax Ordinance as amended and as clarified by Tax Circular 2017/1 from the Israeli Tax Authority (ITA).The new rules:
The special dividend tax rate of 25% applies to individuals who are material shareholders who hold, directly or indirectly, alone or with someone else, 10% of one or more of any means of control in the company, as defined in detail in the law. Individuals include the taxable shareholder of a fiscally transparent “family company” for Israeli tax purposes – similar but not identical to a US LLC or S Corporation.
The 25% tax rate only applies to profits accumulated by the company up to the end of 2016. The dividend must be paid by the company and received by the recipient by September 30, 2017, according to the law, but as this happens to be Shabbat, presumably by October 1, 2017. It seems that dividends declared but not paid by this date may not count.
Furthermore, in each of the years 2017 to 2019, total income from salary, management fees, interest, indexation and other payments by the company to the dividend recipient shall not be more than the average of such payments by the company to the dividend recipient in 2015 and 2016. This condition does not apply to years in which the recipient was not a 10% shareholder, according to the circular. If one shareholder fails to comply with this condition, this does not, per se, spoil things for other shareholders. Capital losses may not be offset against dividends taxed at 25%. In exceptional cases, such as a substantial drop in the company’s income, the taxpayer may apply to the ITA Professional Department for a tax decision.
The circular clarifies that dividend payments include offsets of fringe benefit and loan account debit balances which relate to drawings by the shareholder since January 1, 2013. For drawings before 2013, the circular allows assessing officers to consider treating them as dividends or salary before 2017 (it is not clear why the circular says this).Compliance:
The company must withhold and pay the special 25% dividend tax to the ITA generally by the 15th of the month after the payment, accompanied by Forms 804 and 804/Alef. The company must also hand the dividend recipient form 867 gimel. The dividend recipient must attach this to his or her annual tax return together with a declaration of compliance with the rules. The dividend recipient is responsible for proving the rules were met.What are the advantages of 25% dividend tax?
Paying the special 25% dividend tax results in a tax saving of 5% to 8% of the gross dividend amount. Normally, such a person would pay tax on the dividend at a rate of 30% or even 33% if their taxable income of all sorts in 2017, including capital gains, exceeds NIS 640,000. Therefore, distributing the dividend at a rate of 25% avoids tax later on at higher rates, as well as forced dividends.What is a forced dividend?
The tax director is empowered, after consulting a special committee, to tax a deemed dividend at rates of 25%-33% if retained profits of a closely held company held by five or fewer shareholders and their relatives, as defined. This applies to up to half the profits if they have been retained at least five years (which might have begun in 2012), if the company’s business will not be harmed, tax avoidance or reduction is involved, retained profits amount to at least NIS 5 million, and at least NIS 3m. of retained profits are left.What are the disadvantages of the 25% tax rate?
The tax saving of 5% – 8% is attractive, but leaving the profits in the company may also save tax in the long term.
Suppose a company invests profits of NIS 4m. ($1.12m.) in commercial property that generates a return of 10% per year and distributes just the return each year for, say, 20 years. This may defer tax on the original NIS 4m., i.e. tax avoided is NIS 1m. indefinitely until the property is sold and/or the NIS 4m. is distributed 20 years later, avoiding the forced dividend rules.
But if the NIS 4m. is invested in production equipment or technology instead of being distributed as a dividend, that may create employment.
If the company routinely has to give customers 90 days credit but pays its suppliers and employees within 30 days, there may be insufficient liquidity to pay any dividends.Foreign investors:
Foreign investors, check if a tax treaty gives a better tax rate. More tax may ensue abroad if there is less Israeli tax to credit.
As always, consult experienced tax advisers in each country at an early stage in specific email@example.com. The writer is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.