The Israel Tax Authority (ITA) has issued instructions for raising tax installments for most businesses in Israel, backed by a wave of tax payment demands in the post (ITO Section 62A Instructions 23.12.25).
The ITA wants up to 50% income tax instead of only 23% company tax on “trapped” (undistributed) profits of most private companies with five or fewer shareholders. This is because the new law allocates affected company profits to shareholders and taxes them as if they were freelancers.
Exceptions exist under complicated rules for industrial and certain tech companies, for up to 25% of revenues. This, however, presents many problems.
First, finding the money to pay extra taxes due retroactively from January 2025 onwards. Secondly, income tax of up to 50% is payable by shareholders, but 23% company tax installments may have already been paid by the company. The new ITA instructions aim to sort that out. Third – and most importantly – is that foreign company profits may also be targeted.
What the ITA instructions say
The ITA says that there are two ways affected companies can handle the profits allocable to shareholders: (1) the dividend approach or (2) the expense approach.
Under the dividend approach, company tax should be creditable by the shareholders against their tax liability. This is significant, but conditions apply.
A dividend must be distributed to all of the shareholders. The dividend withholding tax of 25%-30% must be paid by January 16, 2026. Otherwise, interest and inflation indexation begin to accrue.
The company must file forms 856 and 857, which have been expanded to cover trapped profits tax. The taxpayer must report this dividend in Part 11 (Yud Alef) of their annual personal tax return. The 23% company tax credit is claimed in new Boxes 100, 84, and 92.
Under the expense approach, the company records an expense, and the shareholder records freelance business income. To avoid both having to pay tax, the Circular recommends filing company and shareholder tax returns simultaneously, If this isn’t possible, a three-month delay of tax collection procedures and relief from late payment fines may be requested.
Foreign companies
The position of the ITA is that Israeli shareholders should pay up to 50% tax not only on “trapped” profits of Israeli companies, but also trapped profits of foreign companies.
That is, unless the foreign companies’ profits get taxed anyway at similar rates under separate rules for: (1) Controlled Foreign Companies (CFCs – usually 50% Israeli-owned passive companies that pay 15% or less tax) or (2) Foreign Professional Companies (usually 75% Israeli-owned foreign service companies).
In all these cases, where foreign company profits are taxed in Israel, a major headache is double taxation.
A second headache for olim is whether their 10-year Israeli tax holiday disappears. The tax holiday applies to foreign income, but does it still apply to freelance income if they’re in Israel?
Unfortunately, the ITA currently expects anyone involved with a foreign company to figure this out on their own.
What do they need to figure out? Possible scenarios include: challenging the ITA’s jurisdiction – which is fully possible; claiming an expense in the foreign country, which is difficult if the Israeli shareholder(s) didn’t really do anything; claiming a foreign tax credit or Israeli tax credit – both of which are nearly impossible.
In our experience, these scenarios are capable of evaluation and comparison, based on the specific facts of each case.
2% Surtax
Two percent surtax refers to taxes of up to 50% on current year profits of Israeli and foreign companies, commencing with 2025. There is also a 2% surtax on prior years’ undistributed profits, unless at least 5%-6% of those profits are distributed each year. Strangely, an ITA Circular 7/2025 states that the 2% surtax does not apply to profits of foreign companies, but doesn’t give a reason for this.
Comments
Unfortunately, the trapped profit rules hardly encourage olim who own companies abroad to migrate to Israel. If anything, the trapped profit rules encourage Israeli residents to leave Israel. And if they do, there is an exit tax to contend with.
To sum it up, this new taxation rule calls for action now. Consult your accountant soon, if you haven’t already.