On December 22, 2016, the Israeli Parliament enacted new legislation as part of approving selected chapters of the economy policy program and the government budget for the years 2017 and 2018 ("the New Legislation"), including the Taxes chapter (Chapter H) ("the Taxes Chapter") and the Encouragement of Capital Investments chapter (Chapter G) ("the ECI Chapter"). In this article we will briefly review some of the material provisions that form part of the New Legislation.
The Taxes Chapter
The Taxes Chapter includes several provisions concerning the taxation of corporates. Below is a summary of the main provisions of the Israel Tax Ordinance (New Version), 1961 ("the ITO"), which were either added or amended as part of approval of the Taxes Chapter:
- Reduction in the rate of corporate tax - the corporate tax rate will be reduced in 2017 from 25% to 24%. In 2018, the tax rate will again be reduced to 23%.
- Temporary reduction in the tax rate of dividends – according to a temporary order approved as part of the Taxes Chapter, substantive shareholders (holding 10% or more of a company’s means of control (“substantive shareholders”)) will pay tax at a rate of only 25% (instead of 30% + 3% on high earners) on dividends received between January 1, 2017 and September 30, 2017, which are distributed out of retained earnings gained until December 31, 2016.
- The taxation of "employee companies" – the newly-added Section 62A of the ITO allows, under certain circumstances, for tax to be imposed on income derived by a company from activity conducted by an individual substantive shareholder of the said company, as if it were the individual's work income, and levy marginal tax rates on it. This unprecedented section was enacted for the purpose of putting an end to the common practice of senior functionaries, managers, doctors and other senior employees and professionals, who render services to their employer through private companies, and as a result, avoid marginal income tax rates and social security obligatory duties.
- Taxation of substantive shareholder withdrawals - a new section was enacted pursuant to which withdrawals of moneys by substantive shareholders from companies held by them, and utilization of the company's assets for their own personal purposes, would be taxed, in certain circumstances, in the hands of such substantive shareholders, as dividends, salary or business income. This section seeks to resolve the current situation where substantive shareholders withdraw loans and utilize the assets of the companies held by them, without paying taxes on the loan proceeds, save for a small amount of taxes on theoretical interest. The described practice used to be challenged by the tax officers using the argument of artificial transactions according to section 86 of the ITO. This new provision will ease the power of the Israeli tax authorities in forcing tax payers to pay tax on loans and undistributed retained earnings.
The Encouragement of Capital Investments Chapter
The ECI Chapter includes amendments and innovative additions to the Encouragement of Capital Investments Law, 5719-1959 ("the ECI Law"). The newly added article 3B grants significant reliefs to high-tech companies and companies that generate income from intangible assets developed in Israel. The ECI Chapter also includes amendments to the ECI Law, with the aim of making it more attractive for multinational corporates wishing to invest and establish business in Israel. The said amendments also seek to ensure conformity of the Israeli law with the requirements and recommendations of the OECD.
According to the provisions of article 3B enacted as part of the ECI Chapter, technological companies may apply to be recognized as a "Preferred Technology Plant", according to which, their income generated from R&D in Israel ("Preferred Income"), will be subject to corporate tax at a rate of 12% (instead of 16% as was the case under the ECI Law prior to its current amendment), or at a rate of 7.5% (instead of 9% as was the case under the ECI Law prior to its current amendment), if the Preferred Technology Plant is located in certain development areas which located in periphery locations as defined in the ECI Law. Companies belonging to a group of companies whose aggregate income is equal to, or exceeds, 10 billion Shekels (approx. USD 2.5 billion), in a certain year, will be deemed a "Special Preferred Technology Plant", and the Preferred Income derived by it, will be subject to corporate tax at a rate of only 6%.
Other tax benefits are granted to companies deemed Preferred Technology Plants or Special Preferred Technology Plants, in the form of reduced tax on dividends that are distributed out of Preferred Income, to a foreign resident company. Under the circumstances and conditions listed in the ECI Chapter, the dividend will be subject to tax at a rate of only 4%. This tax rate will not prevail over the lower tax rates agreed on in a tax treaty between Israel and another tax treaty country. Other tax benefits are also granted in the event of the sale of IP.
It should be noted that the above provisions will come into force after regulations are enacted regarding the substance of the Preferred Income.There is no doubt that the above amendments and additions to both the ITO and the ECI Law will change the rules of the game for both existing establishments and corporates, as well as corporates interested in operating in the Israeli market, especially high-tech companies and multinationals with Israeli R&D centers. We highly recommend multinational, foreign and domestic corporates to examine the New Legislation described above and consider the post-2016 tax reality in Israel, as a new alternative for conducting business in the global arena.