Tax Authority seeks to end free ride for dividends

Measure will close loophole so that dividends will be distributed only on profits after company tax has been paid.

Money Shekels bills 521 (photo credit: Courtesy)
Money Shekels bills 521
(photo credit: Courtesy)
The Israel Tax Authority will shortly decide on measures to close a loophole in the taxation of dividends, people familiar with the matter told Globes Tuesday.
The committee reviewing the two-stage tax method will advise Tax Authority director-general Yehuda Nasradishi to change taxation rules, so that dividends will be distributed only on profits after company tax has been paid, and a dividend distributed from accounting profits on which company tax has not be paid will be liable to additional tax, the sources said.
If Nasradishi accepts the recommendation, hundreds of millions of shekels a year would be collected in dividends taxes, they said.
Under the current two-stage method, a company tax of 24 percent is paid first, and the 25% dividend tax is only paid after profits have been distributed to shareholders. To date, no specific definition has been set stating the source of profits on which dividends may be distributed.
Consequently, companies often distribute dividends from profits on which no company tax has been collected. As a result, shareholders withdraw profits at a reduced tax rate, effectively saving, at least temporarily, the company tax. This saving is sometimes absolute and final.
The problem has greatly expanded in recent years since the introduction of International Financial Reporting Standards (IFRS), which in certain cases allow the revaluation of assets that can create large accounting profits on which no tax is paid. This accounting reform created accounting surpluses on which the company tax is not collected in the first stage, because the revaluation does not create a tax event, and, after a period of time, the revaluation is distributed as a dividend.
“The question arose whether we at the Tax Authority should ignore the act of revaluation and tax only the receipt of the dividend, or whether we should also create an additional tax event,” a top Tax Authority source said. “Do we want to see the full tax as in every distribution that reaches the final shareholder.”
In view of the changes in accounting rules and other changes in the market in share buybacks and capital reductions, in early 2009, the Tax Authority set up a committee to review this tax lacuna. The 10-member committee has a mandate to examine three issues: taxes on capital reductions, buybacks and dividends on revaluation profits.
“The committee’s recommendations will have a huge effect on the economy,” a Tax Authority source said. “We’re talking about billions of shekels on capital reductions, dividends on revaluation profits and buybacks. It is not for nothing that the committee has been working hard for two years, and its recommendations have still not been submitted. This is a weighty matter, and the committee is doing important work and reviewing all its options to prevent future problems as much as possible.”