Your Taxes: Untrapping corporate profits

The Knesset recently passed an amendment to release profits trapped in Israel by the tax system. The aim is to generate tax revenues and help the Israel Tax Authority (ITA) save face.

Money cash Shekels currency 521 (photo credit: Reuters)
Money cash Shekels currency 521
(photo credit: Reuters)
The Knesset recently passed an amendment to release profits trapped in Israel by the tax system (Amendment 69 to the Law For the Encouragement of Capital Investments, Book of Laws 2385). The aim is to generate tax revenues and help the Israel Tax Authority (ITA) save face.
Briefly, Israeli and foreign multinational corporations want to take out of Israel many billions of shekels that are trapped by the tax system. But if they do, they forfeit Israeli tax breaks under the “alternative track” of the Law for the Encouragement of Capital Investment.
What is the ‘alternative-benefits track’?
Under this track, industrial and technology companies could opt for a no-grants and no-tax package. The company must retain those profits.
If the company distributes those profits, two lots of tax become due: (1) company tax at rates ranging from 10 percent to 25%, depending on the degree of foreign ownership; plus (2) dividend-withholding tax at a rate of 15%.
So dividends are penalized. Total Israeli taxes range from 23.5% to 36.25% for a company on the alternative track that distributes a dividend.
Newer tax breaks
The alternative-track exemption was replaced in 2011 by a new clearer regime of tax breaks for industrial and technological “preferred enterprises.” Preferred enterprises currently pay company tax on all their profits at rates ranging from 5% to 15% (not 25%), and dividends are taxed at 15%.
The resulting total Israeli tax hit therefore ranges from 19.25% to 27.75% for a company with a preferred enterprise under the new 2011 legislation that distributes a dividend.
The controversy
The ITA has claimed that companies with trapped profits were investing them in foreign subsidiaries, and that this somehow amounted to a taxable dividend under the alternative- benefits track rules. Most others dispute that the legislation says so. The ITA reportedly initiated court action, and recently there has been sensational reporting on one Israeli TV channel. So Amendment 69 aims to give companies and the ITA a way out: pay reduced tax.
The amendment
Companies with untaxed trapped (or frozen) profits as at December 31, 2011, can elect to “unfreeze” part or all of them by paying Israeli company tax at a rate reduced by a factor of 30% to 60%. This tax is essentially calculated as follows: First, calculate the tax-benefit factor: 30% of unfrozenprofits proportion plus 30%.
Second, calculate the tax factor: 100% minus the taxbenefit factor.
Third, calculate resulting reduced tax rate (cannot be less that 6%).
Fourth: apply reduced tax rate to unfrozen profits.
An example
Company X is an Israeli industrial or technology company with frozen profits of NIS 100 million at the end of 2011. It wants to unfreeze NIS 50m. (50%) of them. Since the company was more than 51% Israeli owned, a 25% rate of company tax would have applied in the year(s) those profits were earned.
First, tax benefit factor: (30% x 50%) + 30% = 45%.
Second, tax factor: 100% – 45% = 55%.
Third, tax rate: 55% x 25 % = 13.75%.
Fourth, tax: NIS 50m. x 13.75% = NIS 6.875m.
The procedure
The election to unfreeze profits is made by filing Israeli tax form 969 by November 11, 2013 (one year after publication of Amendment 69). The form details the above calculation.
The resulting tax must be paid within 30 days.
The election is irrevocable.
What does it mean?
The unfrozen profits can be used for any purpose. But the above tax is company tax only. If the company concerned distributes a dividend, it will be subject to a further 15% dividend-withholding tax. In addition, the company must reinvest a prescribed amount (see below). Any frozen profits (after November 11, 2013) will be subject to the alternativebenefits tax if they are deemed to be distributed.
Reinvestment conditions
A company that elects to unfreeze profits has five years to reinvest in an industrial enterprise (as defined in detail) in Israel in one or more of the following: productive assets (not buildings); research and development; or salaries to extra employees (not office holders) over and above the 2011 average workforce.
The “prescribed investment amount” is 30% of the unfrozen profits multiplied by the unfrozen-profits proportion and by the rate of company tax that would have applied in the year the profits were earned.
In the above example, the prescribed investment amount is 30% x NIS 50m. x 25% tax rate = NIS 3.75m.
If the company fails to invest this amount within the five years, the under-investment must be paid as additional tax within 30 days thereafter, with interest and indexation from the date the unfreeze election was filed to the date the tax is paid.
The five years run from the beginning of the tax year in which the unfreeze election was made. This means companies are unlikely to file such an election before January 2013.
If the unfreeze tax is the minimum 6% rate, an amended prescribed investment amount applies.
The need for this amendment remains questionable. The terms are restrictive, and some of the definitions are not clearly drafted. It remains to be seen whether Israeli companies that enjoyed the alternative-benefits track will elect to unfreeze profits and pay the tax. They may not want to pay a dividend and thus avoid any tax. They may claim that investing in foreign marketing subsidiaries is legitimate and no tax is due. Or they may have other already taxed profits to distribute.
As always, consult experienced tax advisers in each country at an early stage in specific cases.
Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.