"Wallet Company" is a common form of incorporation, utilized mainly by small business owners and professionals, such as doctors, lawyers, accountants, appraisers and engineers, who provide various services through companies under their control.
The Israeli tax implications of such incorporations have not yet been finalized and remain a subject of dispute between tax authorities and tax consultants. In October 2013, the recommendations for legislative amendments regarding the taxation of "Wallet Companies" were published by the Committee for Economic and Social Reforms headed by Prof. Manuel Trachtenberg, but these recommendations have not yet been legislated.
The committee analyzed the following common types of "Wallet Companies" and suggested the following tax treatments:
- Officers / Wage Earners Company - a "small company", as defined in Section 76 of the Income Tax Ordinance ("Small Company" and "ITO", respectively), which derives income from the operations of a shareholder as an officer of another company or a company that liaisons the employer-employee relationship between the shareholder and the services receiver. The committee recommended subjecting its income to taxation on an ongoing basis at the shareholder level at the marginal tax rate.
- Barrier Company – A Small Company which at least half of its yearly income is passive income. The committee recommended taxing 50% of the company's net liable income and its exempted income, which origin from passive income (deemed dividend).
- Accruing Company – an Israel resident company (which is not a Barrier Company) that has "cumulative surplus earnings" (i.e. after-tax-earnings that exceed 25% of the company's aggregate income, which was not distributed as a dividend). The committee recommended taxing the amount of the cumulative surplus earnings at a yearly fixed rate of 1%.
In addition, courts have repeatedly considered tax disputes concerning "Wallet Companies" but the rulings on the subject vary from case to case. This is reflected in the following two judgments delivered by judges of the District Court in Tel Aviv-Jaffa in recent months:
- Tax Appeal (Tel-Aviv) 28320-05-12 Tel Aviv Development Foundation v. Tel Aviv 5 Tax Assessor considered the employment agreement of Abraham Ben-Shoshan, CEO in a foundation, whose salary payments were made against invoices produced by a company under his exclusive control. It was ruled that the payments were not management fees but work income, inter alia, for the following reasons: (a) the wording of the employment agreement reflects the personal engagement of Mr. Ben-Shoshan instead of the company under his control that was incorporated after the signing of the agreement; (b) indications external to the agreement evidence that the payments made to the company were actually wages of the CEO, i.e. the date of the establishment of the company, the salaries and dividends not being withdrawn from Mr. Ben-Shoshan's company, the filing of an employee card (Form 101) on an ongoing basis by Mr. Ben-Shoshan, the issuance of pay slips to Mr. Ben-Shoshan by the appellant, documents settling accounts between Mr. Ben-Shoshan and the foundation upon the termination of contract, redemption of vacation days upon the termination of the contract, etc.; (c) the existence of an employer-employee relationship between the CEO and the appellant (i.e. social payments granted to the CEO, the authority and supervision of the appellant's Executive Board of the CEO and the telephone and automobile at his disposal).
- Tax Appeal 1065-09 Ali Baigel v. Petah-Tiqwa Tax Assessor considered an agreement under which "Liraz Marketing Batteries (1998) Ltd" (hereinafter-"Liraz 1998") undertook to provide management services by the appellant (its single shareholder) to "Liraz Marketing Batteries (2003) Ltd" (hereinafter-"Liraz 2003"), which was held by the appellant at the rate of 48.5%. The court ruled that no tax will be imposed on the appellant in respect of the management fees under Section 2(2) of the Income Tax Ordinance (i.e. the management fees were not considered as work income) in light of the absence of an employer-employee relationship, following the analysis of the agreements signed between the parties (i.e. the lack of supervision of the appellant's work), as well as the depositions and testimonies of the parties involved. In addition, it was ruled that the appellant will not be regarded as an independent contractor providing personal services and, accordingly, his income will not be taxed under Section 2(1) of the Income Tax Ordinance, in light of the fact that the purpose of the agreement was to provide management services merely business advice and in light of the testimony of a shareholder who regarded the appellant and Liraz 1998 as one entity. Also, it was ruled that the transaction was not artificial because there was a commercial rationale in transferring the management fees to the company (as the new investor in Liraz 2003 conditioned his investment in the establishment of this new, separate company), and because the provision of management services through a company is a common practice in the business world.
In summary, the classifications of payments to such companies providing management services are still controversial in terms of the tax law and it seems that each case needs to be considered in accordance with its unique set of circumstances. In some cases, the agreements are subject to reclassification by the tax authorities as employment agreements or as agreements concerning the provision of direct services by an independent contractor. In order to minimize the exposure to such a reclassification - it may be advisable to pay close attention to all of the aspects of the transaction, for example:
- Establishment of the consultancy entity as early as possible before the date of the execution of the service agreement;
- Introduction of additional activities to the 'repertoire' of the consultancy entity;
- Adding other shareholders, directors and/or employees to the consultancy entity;
- Verifying that the characteristics of employee-employer relations (i.e. issuance of a pay slips, 101 forms, social payments by the company receiving the services, supply of car/phone and provision other services, authority and supervision of the services rendered, etc.) are not part of the service agreement.