Israeli Tax Authority Reviews Highly Successful Undistributed Profits Reform Amid Real Estate Concerns
Israel's tax reform on undistributed corporate profits, initially part of the state budget measures, has significantly exceeded expectations by doubling projected government revenue. The reform, designed to curb tax avoidance by companies accumulating profits without distribution, generated between 15 and 20 billion shekels in revenue last year, far surpassing initial estimates of 5 to 6 billion shekels annually. This success was confirmed by the Israeli Tax Authority and reflected in a 14% overall increase in tax collection in 2023.
The reform targets "shell companies" and holding companies that accumulate profits without reinvesting them in business expansion, aiming to neutralize incentives for tax-driven company formations. It requires companies exceeding certain profit thresholds to distribute dividends or face a 2% tax penalty. However, the law differentiates between companies investing in real estate for sale and those investing in rental properties, taxing the latter more heavily.
This distinction has skewed the real estate market, discouraging investment in income-generating properties, especially office buildings, which risks cooling the sector. Consequently, the Tax Authority announced it will reassess the reform ahead of the upcoming Arrangements Law, considering possible tax reliefs to encourage investment in rental real estate without undermining revenue. Such changes face challenges due to the government's reliance on this tax amid rising debt-to-GDP ratios and soaring interest payments.
The reform's origins trace back to late 2024 recommendations led by then Finance Ministry Director General Shlomi Heisler, who views the initiative as a major success but acknowledges the need to fine-tune its impact on real estate investments. Finance Minister Bezalel Smotrich also recognized the necessity for adjustments to avoid suppressing economic activity. Industry representatives, including contractors, report negative effects primarily on the rental real estate market, noting that the anticipated reinvestment of withdrawn funds into housing did not materialize due to purchase taxes.
With government expenditures rising sharply since the war and debt servicing costs ballooning, the 2027 budget is expected to include tough tax measures. Experts suggest any tax relief will likely target wage earners rather than capital owners. The ongoing review aims to balance maintaining robust tax revenues with mitigating unintended consequences on the real estate sector.
