Israel Considers Revising Controversial Tax on Undistributed Corporate Profits Affecting Small Businesses

Israel's Tax Authority is reconsidering the controversial tax on undistributed corporate profits introduced in the 2025 Economic Efficiency Law. This law imposes an additional tax on so-called "trapped profits" of companies, which have already paid corporate tax. Specifically, small and medium-sized companies that have accumulated profits and invested them in rental real estate must annually distribute part of these profits and pay a dividend tax or a 2% penalty tax. However, large companies with annual revenues exceeding 30 million shekels, typically publicly traded firms, and contractors selling properties as part of their regular business are exempt from this tax.

This exemption creates a disparity that disproportionately burdens small and medium businesses, which are key drivers of economic growth, while larger companies avoid the tax. The law also applies retroactively to profits earned before its enactment, changing the rules midstream. Furthermore, the law favors properties used for a company's own operations over rental properties, incentivizing companies to purchase rather than rent assets. Industrial companies with manufacturing activities are also exempt from the tax on rental income, leading to further inconsistencies.

Tax Authority Director Shai Aharonovitch recently acknowledged the need to review the trapped profits reform due to its potential negative impact on the economy. Legal experts advocate for a swift legislative amendment to eliminate these distortions and provide clarity to taxpayers. Until then, small and medium business owners are forced to engage in complex tax planning, which may lead to future disputes with tax officials. The article was authored by attorney and CPA Ehud Barzilai and attorney Liron Ben Mayor.