Israel Tax Authority Proposes Higher Tax on Retained Earnings
Translated & summarized from Globes by baba
The Israel Tax Authority is proposing to increase the mandatory dividend payout from 6% to 8% for companies under the "trapped profits" reform, which began in January 2025. This move is expected to generate an additional NIS 1-2 billion annually, as the reform has already significantly exceeded revenue expectations. While critics argue this will harm investment and economic growth, the Tax Authority cites the state's financial needs and suggests the reform is unlikely to be repealed. The proposal is part of preparations for the 2027 austerity bill.
The story in 5 lines · by baba
- Israel Tax Authority proposes raising mandatory dividend payout from 6% to 8% for companies.
- The "trapped profits" reform, enacted in January 2025, has already exceeded revenue expectations.
- The proposed increase is expected to generate an additional NIS 1-2 billion annually for the state.
- Critics argue the reform depletes companies' investment capital and harms economic growth.
- The Tax Authority cites state financial needs and suggests the reform is unlikely to be repealed.
Despite ongoing efforts by the economy and tax experts to repeal the "trapped profits" reform, which took effect in January 2025 and imposed additional taxes on most companies, the Israel Tax Authority is considering a contrasting move: increasing the required dividend payout threshold from the current 6% to 8%. This proposed change is expected to generate an additional NIS 1-2 billion annually, supplementing the billions already collected since the reform's implementation, which significantly exceeded initial collection forecasts. In its first year, the reform brought in approximately NIS 20 billion, double the projected amount.
The Tax Authority is also contemplating a grace period for businesses before implementing the higher threshold. This could involve a temporary order maintaining the current rate, allowing companies to distribute dividends before the increase. If such an order is enacted, the Authority anticipates substantial one-time revenue, similar to a previous temporary order that permitted a 5% payout for the first year instead of the fixed 6%.
The "trapped profits" reform, in effect for nearly two years, mandates the distribution of accumulated profits above a certain threshold and taxes on these dividends, or a 2% "penalty tax." It also requires controlling shareholders of "wallet companies" to pay marginal tax on undistributed profits exceeding 25% of turnover for companies with turnovers up to NIS 30 million. The reform faced strong criticism from professional bodies, including bar associations and accounting and tax advisor guilds, who argued it fundamentally altered corporate taxation and interfered with business decisions. Despite legal challenges, including petitions rejected by the High Court of Justice, criticism persists.
Director of the Tax Authority, Shi Ahronovitz, indicated that the legislation would be reviewed after two to three years of implementation. He suggested that the review, which has begun in preparation for the upcoming 2027 austerity bill, is unlikely to lead to the reform's repeal. Instead, he proposed increasing the dividend distribution requirement to 8% from 6%, citing the state's financial needs. Ahronovitz acknowledged the criticism but stated that canceling the reform would necessitate finding the funds elsewhere, emphasizing the country's projected budget deficits.
The proposed change specifically targets Section 81 of the "trapped profits" legislation, which applies to closely held companies. This section mandates a 6% dividend payout to avoid tax or a penalty. The Tax Authority collected approximately NIS 10 billion in 2025 from dividend distributions under this section alone, far exceeding the initial NIS 5 billion estimate. The collection period extends until the later of the 2025 tax report submission or the end of 2026, with the Authority expecting an additional NIS 2 billion. The Authority is considering allowing the section to be applied upon actual tax report submission, potentially shifting some 2025 revenues into 2027. This flexibility is partly due to exceeding 2026 collection forecasts, reducing the immediate need for these funds.
Professional bodies and industry representatives strongly oppose the proposed increase, arguing it will deplete companies' investment capital, harm economic growth, and negatively impact future tax revenues and Israel's economy. They contend that the reform already restricts companies' financial flexibility for investments and saving for unforeseen circumstances, and that increasing the payout requirement will exacerbate these issues.
