We wish to inform you of forthcoming changes in legislation in the wake of the Economic Efficiency bill (legislative amendments to achieve budget goals for 2017 and 2018), – 2016. The legislative amendments are currently under discussion in the Israeli Knesset Finance Committee, and are planned to enter legislation after the aforementioned law is approved in the second and third reading by the Knesset. It should be noted that the bills described in the following could be modified in the final legislation brought before the Knesset plenum.
A. Multiple Apartment Tax
As part of the government’s efforts to combat the rise in residential property prices in Israel’s economy, and to increase the supply of residential apartments, a new tax has been proposed, to be imposed on owners of three or more residential apartments (“Multiple Apartment Tax”). The aim of Multiple Apartment Tax is to motivate owners of several investment properties to sell some of these apartments. The government thus seeks to increase the supply of residential apartments in Israel’s economy.
The bill as it is know today includes imposing Multiple Apartment Tax on whoever owns at least three apartments, where the tax shall apply from the third apartment, and the maximum tax paid on each apartment shall not surpass ILS 18,000 per annum (approximately USD 4,500). The tax is calculated according to a formula set out by law, and is derived from the value of the apartment and other criteria. As far as we know, the Multiple Apartment Tax shall apply to whoever holds 249% cumulative ownership of residential apartments; in other words, 2.5 apartments. The taxpayer may choose which apartment the above tax shall apply to; if not, this shall be determined by the Tax Authority.
It should be noted that from the press release made by the finance committee before the final draft of the law discussed in the committee was publicized, it is evident that the Ministry of Finance agreed to a compromise, according to which Multiple Apartment Tax shall not apply to apartment owners whose two additional apartments are valued at up to ILS 1.15 million (approximately USD 285,000).
Furthermore, according to the bill, it follows that whoever became the owner of three apartments or was removed from this definition over the current year will only be taxed partially for each of the apartments he owns, taxable under the Multiple Apartment Tax, corresponding to the part of the years the apartment was owned by him.
B. Forced Distribution of Company Surplus – Section 77 of the Income Tax Ordinance
Section 77 of the Israeli Tax Ordinance, in its current version, permits the director of the Israeli Tax Authority (the “Director”) to order a company to distribute its undistributed profits to the extent that the terms of the section have been fulfilled, including: a. The company is a closely-held corporation (a company under the control of no more than five people); b. The company has not distributed its profits as a dividend to shareholders until 12 months from the end of the tax years; c. The distribution of all or some of the profits shall not jeopardize the existence of the company or compromise the development of its business; d. The results of non-distribution is avoiding of tax or reduction in tax. The authority of the director to order distribution is limited to a period of three years after the 12 month period from the end of the tax year, to which the distribution of profit would be applied, and after the director has consulted the committee on the matter. The aforementioned section shall not apply when a company has distributed at least 75% of its taxable income.
In practice, the director makes very little use of the aforementioned section, due to the need to consult a committee for this purpose. In addition, the director’s authority to order a forced distribution expires three years after the end of a given tax year.
In light of the accumulation of profits by Israeli companies not distributed to shareholders, for no economic purpose connected with company business, it has been proposed to amend the section in order to give the director the authority to order distribution of profit with no economic purpose in the company.
According to the bill, it is proposed to enable the director to order distribution of profits in a company, if it has not distributed at least 50% of its profits over a period of five years from the tax year under discussion. The distribution shall apply to a company which has amassed over ILS 5 million cumulative profit (approximately USD 1.25 million), and only if its cumulative profit is no less than ILS 3 million (approximately USD 0.75 million) after distribution of cumulative profit with respect to the tax year under discussion. The authority of the director to order the distribution is not limited in time, and he may do so five years have lapsed since the end of the tax year for which the distribution of profit is being examined, and with respect to the entire balance of surplus accumulated until that year from the day the company was established.
C. Deemed dividend distribution in certain circumstances
The aim of this section is to deal with the phenomenon of withdrawal of funds or assets from the company by its shareholders, without them having been distributed to shareholders as dividends, and without their being returned to the company for long periods of time or without being returned at all. Withdrawals from the company are classified by its shareholders as a loan to be returned to the company. Under the current law, owners’ withdrawals are taxed on income valued at the rate of conceptual interest or land use fee; however, the latter are not equivalent to the tax that would be owed if the funds or assets were distributed as a dividend to shareholders.
In light of this, an amendment to the Israeli Tax Ordinance was proposed, according to which withdrawal of funds or assets, including loans granted to related companies (i.e. placing an asset at the disposal of shareholders or their relatives) by a substantial shareholder or his relative shall be considered income from dividend, salary, business or profession to the shareholder, according to the circumstances. For example, if there is a balance of profit for distribution in the company, the deemed income shall be classified as a dividend. If the company has no profits for distribution, and employer-employee relations exist between the substantial shareholder and the company then the income shall be classified as income from wages;
if no employer-employee relations exist then the income shall be classified as income from a business or a profession.
In the case of withdrawal of funds from the company, the date of taxation shall fall at the end of the tax year following the withdrawal of funds; in the case of use of company assets, the date of taxation shall fall at the end of the first year of use of the asset, and at the end of each of the following years, until the date on which the asset is returned to the company. It should be noted that until the date of taxation for a withdrawal or use of company assets, the said provisions shall apply – attribution of conceptual interest income to the shareholder, or attribution of income with respect to market price of use of asset.
As noted above, the aforementioned has been taken from the bill and amendments to it while under discussion in the finance committee and are subject to change, for as long as the final bill to be debated in the Knesset towards the second and third readings has not been publicized. We shall update you in the upcoming quarterly tax alert on the final changes in legislature approved by the Knesset.