Finance C'ttee passes trapped profits taxation bill

Bezalel Smotrich  credit: Yossi Zamir
Bezalel Smotrich credit: Yossi Zamir

The new legislation will make maintaining a personal service company much less worthwhile.

The Knesset Finance Committee has approved the main reform in the 2025 budget. After a prolonged campaign against the move by business organizations, a majority of Knesset members on the committee voted in favor of the complicated law that will enable the state to collect tax on the estimated NIS 150 billion of trapped profits in personal service companies.

"Trapped profits" are profits accumulated in companies on which only companies tax, at a rate of 23%, has been paid. Only if the profits are distributed as a dividend will additional tax of up to 30%, plus a surtax in many cases, be payable as income tax.

The Ministry of Finance’s original proposal set a new tax of 2% annually on all trapped profits. In the course of the discussions, an alternative track was added, mainly intended for holding companies, whereby the tax can be replaced by a dividend distribution, at first of 5% of the accumulated amount, and 6% from 2026.

"The Ministry of Finance wants to make up for the deficit caused by the war, and so in effect it is forcing shareholders to distribute a dividend even if they didn’t plan to do so," explains Ai Maman CPA, a partner at the Rabinowitz Even Maman accounting firm. "In addition, the Ministry of Finance has created a new method calculating companies tax that will apply to companies from 2025, in which two rates of tax will apply to profits retained in a company: companies tax on profits representing up to 25% of turnover, and a marginal rate on profits in excess of this equivalent to the rate of tax payable by the shareholders. As a result of this calculation method, shareholders in a company will be able to accumulate much less trapped profits in future years."

To which companies will the law apply, and which one will be exempt?

"The new rules will apply to companies with up to five shareholders with annual turnover of less than NIS 30 million, and holding or investment companies with significant passive shareholders’ equity. This captures personal service companies, the liberal professions, accountants’ and lawyers’ partnerships, and mid-size businesses," Maman says.

For which companies is it worth choosing the alternative track of a compulsory dividend distribution, and for which is the original track of a 2% tax on cumulative profits preferable?

"Most companies will choose the annual dividend distribution of 5-6%, because after the tax payment they are also paying money to the shareholders, which means that, financially, this only amounts to an earlier payment of tax. I see no sense in choosing the 2% alternative, because that is a fine in every respect, that only erodes shareholders’ equity. It may be that a few, unusual companies will choose to use that option, but it is still not clear on what proportion of shareholders’’ equity the fine will have to be paid. If the calculation results in a negligible tax payment, then there’s logic in choosing it."

What is the significance of the rise in surtax on dividend distributions, and is it worthwhile for companies to distribute profits before the end of 2024?

"The new 2% surtax will apply to capital gains only. It does not affect dividend distributions of other income, and it applies only from NIS 720,000 annually. It’s not clear why all kinds of companies have reportedly rushed to pay dividends, because the new surtax will not apply to dividends. In any event, the decision to pay a dividend can be made up until December 31, and the reporting to the authorities is until January 15, 2025, so there’s no sense in rushing to pay a dividend just because of the reform."

The complicated new legislation has succeeded in confusing even the experts. While Maman interprets the new surtax as not applicable to dividends, others in the field believe that it will apply to them as to other income from capital, apart from a certain exemption on the sale of a home.

How can companies set up correctly in the new situation as far as tax planning is concerned?

Maman: "There’s no real tax planning that can be carried out at the moment, except that any self-employed person (osek mursheh) who planned to set up a limited personal service company should think again. The question arises whether it’s still worthwhile under the new taxation method, since maintaining a limited company is more expensive than being self-employed. In addition, investors in the capital market who hold securities in profit by more than NIS 720,000 should consider selling in 2024 and paying the current rates of tax (25% on capital gains plus a 3% surtax), rather than the 30% applicable from 2025."

Published by Globes, Israel business news - en.globes.co.il - on December 29, 2024.

© Copyright of Globes Publisher Itonut (1983) Ltd., 2024.

Bezalel Smotrich  credit: Yossi Zamir
Bezalel Smotrich credit: Yossi Zamir
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