The discussions on the 2025 state budget at the Ministry of Finance became heated last week when Minister of Finance Bezalel Smotrich presented to top ministry officials a proposal by the prime minister’s economic adviser Prof. Avi Simhon, who is pushing for additional tax benefits on the distribution of dividends from trapped earnings. The professionals at the Ministry of Finance have expressed determined opposition to such a move.
Simhon, backed by Prime Minister Benjamin Netanyahu, sees in the release of trapped earnings an opportunity to inject large sums into the state’s coffers in the short term, as a way of dealing with the heavy costs of the war.
According to Simhon, such a program could yield NIS 20 billion in taxation on the distribution of NIS 80 billion in trapped earnings. Simhon’s figures are based on an estimate that accumulate trapped earnings at companies amount to some NIS 700 billion.
The Ministry of Finance officials argue that the proposal amounts to a fire sale that will reduce state revenues in the long term. They say that previous special campaigns have already given the companies substantial benefits, and that repeating them will create perpetual expectations of future campaigns, which will encourage companies to continue accumulating earnings instead of routinely distributing them.
Israel Tax Authority director Shay Aharonovich has expressed a stance in line with the Ministry of Finance’s approach, saying at conferences that a new campaign with tax breaks would in effect be bringing taxation forward, that is to say, it would diminish tax revenues in future years.
According to Simhon however, even if some future taxation is brought forward, since the fiscal deficit is forecast to peak this year and to moderate gradually over the next few years, there is justification for raiding these savings now. In addition, Simhon has presented analysis indicating that in previous rounds, the subsequent decline in tax collected on dividends was lower than the amount collected at the time, so that it was not just a matter of bringing collection forward, but also of releasing dividends that would otherwise have remained trapped.
Carrot without a stick
Trapped earnings are the result of a taxation policy designed to encourage investment in the economy. Under the Law for the Encouragement of Capital Investment, companies have received substantial tax benefits on profits arising from approved investments, on condition that these profits are not distributed as dividends. The aim was to encourage companies to invest their earnings in further business development rather than distributing them to their shareholders.
An incentive was thus created for companies to accumulate earnings without distributing them, in order to avoid paying tax. In Israel’s two-stage taxation system, company profits are taxed twice, once at the company level, and again when they are distributed as dividends to shareholders. The trapped earnings benefit from substantial deferment of tax, since they are taxed only at the company level (at reduced rates) and not at the shareholder level.
Published by Globes, Israel business news - en.globes.co.il - on June 25, 2024.
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