One of the ways of dodging the new “trapped profits” tax on most private companies is to start a full or partial liquidation of the company concerned by November 30.
The Israel Tax Authority (ITA) has just issued some frequently asked questions (FAQs) that aim to clarify how this might be done.
Trapped profits refers to undistributed profits. The rules are complex, but deadlines are approaching. Here is an overview of some aspects:
Who is affected?
Anyone who is a shareholder in a private company engaged in business or investment, e.g., real estate, with five or fewer shareholders should be aware of the new Israeli trapped-profits tax rules by now. Related parties count as one shareholder.
The Knesset passed the relevant amendment at the end of 2024, and it went into effect on January 1. The rules more than double the tax on corporate profits from 23% to 50% in many cases. Foreign companies with Israeli resident shareholders are not excluded, nor are olim (new immigrants).
The new taxes
The new trapped-profits tax includes: (1) a surtax of 2% generally on undistributed prior-year profits of many companies; (2) up to 50% tax for shareholders on current-year profits of most nonindustrial non-tech companies to the extent those profits exceed 25% of revenues.
Alternative options – liquidate or distribute assets in kind:
Instead of applying the trapped-profits tax rules every year to a company, the tax law provides two ways of dropping out: (1) liquidate the company, and transfer all its assets and liabilities to the shareholders; or (2) don’t liquidate the company, but transfer assets to the shareholders (Economic Efficiency Law, Section 6; and ITA Tax Circular 3/2025).
That way the shareholders pay taxes at personal tax rates on income from those assets, which is what the ITA wants. Personal tax rates range up to 50%, but exceptions exist.
For example, individuals can choose a flat tax rate 10% on gross rent from Israeli residential property and forego expenses. That may sound good, but other taxes are still payable, and the individuals don’t enjoy limited liability from legal claims, e.g., lawsuits against an individual landlord. Only companies enjoy limited liability.
Under both of the above alternatives, the deadline for distributing assets is November 30.
Liquidation alternative
Under this option, the deadline for starting a liquidation is this December 31. Undistributed profits at the end of 2024 must also be distributed by the end of 2025.
There is no capital-gains tax, land-appreciation tax, or purchase tax (for Israeli real estate), but accumulated undistributed profits are taxed like dividends. Usually, the tax rate for dividends is 30%-35%, but up to 50% is possible in some cases.
When shareholders (or ex-shareholders) sell an asset, they can treat it either: (1) like a sale of the assets distributed to them, applying the company’s depreciated cost (no “step-up”) and acquisition date; or (2) like a sale of shares applying the share acquisition date. Lengthy additional requirements apply if any shareholder is a company rather than an individual. Specialist advice should be sought.
Asset distribution to shareholders alternative
In this case, at least 91% of the shareholders must participate. There are detailed rules for allocating loans and mortgages to distributed assets.
A reading of the Circular suggests that loans may actually trigger higher taxation if leveraged assets exceed distributable profits. A subsequent sale is also taxable according to another formula.
VAT
Briefly, real estate distributed and later sold may be liable to 0% VAT, but 18% VAT would apply if input VAT was claimed for non-real-estate assets.
FAQs
The FAQs do little to dispel the complexity. For example, regarding loan allocation to assets, the FAQs suggest considering debt forgiveness (FAQ2). (Comment: This is extreme at the Israeli and international levels.)
In the case of non-eligibility for any reason, the FAQs say a proposed liquidation or asset transfer may be reversed, but not for real estate. (Comment: check especially the legal side of any change of mind.)
Conclusion
These temporary rules are complicated. Issues may well arise, especially if there are borrowings. VAT may apply in unexpected instances. Detailed planning and calculations are called for, and deadlines are looming. Where there is an international dimension, take advice in all countries concerned.
All in all, this opportunity to reorganize by full or partial liquidation expires soon. But these rules are not the greatest thing since sliced bread.
Other ways exist for addressing the trapped-profits taxation at the international level.
As always, consult experienced legal and tax advisers in each country at an early stage in specific cases.
leon@hcat.co
The writer is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.