TAX NEWSFLASH – APRIL 2025

As previously noted by us, on 31 December 2024 the Economy Efficiency Law (Legislative Amendments for Achieving the Budget Targets for 2025) (Taxation of Undistributed Profits), 5785-2024 (“the Efficiency Law”) was published, bringing about a revolutionary reform in the Israeli corporate tax regime.  As may be recalled, this reform, at its various stages, comprises new and stringent tax decrees that already have application to closely held companies.  Coupled with these stringent tax decrees, the Efficiency Law also contains an amelioration temporary provision, facilitating the optimization of existing tax structures, either through the liquidation of closely held companies (“the Liquidation Track”) or a “retrieval” of assets (including real estate assets) from active closely held companies without opting for liquidation (“the Asset Transfer Track”), while taking advantage of the far-reaching tax benefits (“the Temporary Provision”).

We wish to update you that on 3 April 2025 the Israel Tax Authority (“the ITA”) published Income Tax Circular No. 03/2025 titled – Section 6 of the Economy Efficiency Law (Legislative Amendments for Achieving the Budget Targets for 2025) (Taxation of Undistributed Profits), 5785-2024 Temporary Provision (“the Circular”).  The Circular provides important guidelines clarifying the ITA’s stance regarding the principles of the Temporary Provision and its conditions, as detailed below:

The Designated Population for Application of the Provisions of the Temporary Provision

• The Circular clarifies that the Temporary Provision can apply to one or more closely held companies (as such term is defined in section 76 of the Income Tax Ordinance [New Version], 5721-1961 (“the ITO”)), at the election of the tax payer, provided that all the company assets will be transferred to the individual shareholders.
• Shareholders of closely held companies wishing to fall within the realms of the Temporary Provision are required to submit a detailed application on the subject to the Professional Division at the ITA, by adopting an array of preliminary taxation resolutions.  To our understanding, this speaks to an attempt by the ITA to make the process for applying the Temporary Provision more efficient and to grant expeditious approvals to applicants seeking a sort of “green track” whose conditions are known and agreed to in advance.  Nevertheless, the Circular clarifies that where the closely held company is not or was not at any time whatsoever from the date of its incorporation an Israeli resident and/or where the closely held company is a group of individuals whose profits or losses are attributable to the holders of rights therein (for example a family company or a house company) and/or where the closely held company is held by a shareholder who is a foreign resident/returning resident/veteran returning resident/new immigrant, then an individual application will be required in order to approve application of the Temporary Provision.

General Conditions for Implementation of the Temporary Provision

• The Circular clarifies that the provisions of section 93 of the ITO, which determine the tax arrangement that applies to the routine liquidation of a company (whereby a tax liability is created during the liquidation process both at the liquidating company level and at the shareholder level), will not apply at the time of liquidation of a closely held company implemented pursuant to the provisions of the Temporary Provision.
• To the extent the Liquidation Track will be selected, the liquidation process should begin no later than 31 December 2025, and will be implemented in accordance with and subject to the provisions of applicable law.
• The date of the taxable event during the liquidation process with respect to distributable profits generated until 31 December 2024 will be the actual date of liquidation.  Conversely, with respect to distributable profits generated as of 1 January 2025 until conclusion of the liquidation process (“the 2025 Distributable Profits”), the date of the taxable event will be the date of conclusion of the liquidation process or 31 December 2025, whichever is the earlier.  In this context, calculation of the tax liability with respect to the 2025 Distributable Profits and its payment will be made not later than 31 March 2026.  The tax amount will bear linkage differentials and interest beginning from the date of the tax event, as noted above and ending on the date on which payment of the entire tax is actually made.
• Within the context of the liquidation process, the assets and liabilities will be transferred to the shareholders pro rata to their respective rights in the company.
• The transfer of assets from the company to its shareholders will be effected by 30 November 2025.  The date of creation of the tax liability upon transfer of the assets will be the date of transfer.
• The transfer of assets to the shareholders will be effected without their designation being changed.
• Under the Liquidation Track – all of the assets and liabilities of the company will be transferred to its shareholders.
• The provisions of section 121B of the ITO, concerning the application of surtax, will apply to a transfer of assets effected pursuant to the Temporary Provision.

The Liquidation Track

1. Taxation of the liquidating company
   • Absence of tax liability – a closely held company that complies with the conditions of the Temporary Provision will not be charged tax in accordance with the provisions of the ITO and/or the Real Estate Taxation (Appreciation, Sale and Acquisition) Law, 5723-1963 (“the Real Estate Taxation Law”) for tax events deriving from the transfer of its assets and liabilities to its shareholders.
   • Identity of assets being transferred – all the assets and liabilities that are to be transferred to the shareholders as part of the liquidation process will be considered as transferred under the Temporary Provision, namely, a transfer of selective assets will not be possible.
   • Non-transferable assets – losses and credits for tax purposes, preferred advances and the like, are assets that cannot be transferred to the shareholders as part of the liquidation.
   • Change of structure – assets transferred from the company to its shareholders within the context of the Temporary Provision will not be deemed a transfer in breach of the provisions of Part Two of the ITO (change of structure) regarding “the required period”, provided that the change is implemented by 31 December 2024.
2. Taxation of the company’s shareholders
   • The tax liability – the shareholders of the liquidating company will be subject to dividend tax in the amount of distributable profits, based on their holding percentage.  It goes without saying that the tax liability to which the shareholders in a liquidation implemented pursuant to the Temporary Provision will be subject is limited to the amount of distributable profits generated in the company and does not derive from the value of assets to be transferred to them within the ambit of the liquidation.
   • Calculation of distributable profits – calculation of the amount of distributable profits will be done as of the date of incorporation of the company, even if it was incorporated prior to 1 January 1996 (as opposed to the calculation of distributable profits that is done not pursuant to the Temporary Provision), until conclusion of the liquidation.
   • The transfer of liabilities – the transfer of liabilities from the company to its shareholders within the ambit of a liquidation process implemented pursuant to the Temporary Provision does not take into account the calculation of distributable profits and/or the tax liability of the shareholders.
   • Exemption from acquisition tax – transfer of a right in land or a right in a real estate corporation to the shareholders within the context of the Temporary Provision will not create a liability in the scope of acquisition tax.
3. The cost and date of the acquisition of assets that are transferred to the shareholders

Generally, the assets and liabilities to be transferred to the shareholders within the context of the liquidation process will be transferred on a cost basis (and not based on their value on the date of transfer).  Thus, in order to calculate the cost of each asset being transferred within the context of the liquidation, the shareholders will be entitled to elect either of the two options below, provided that the selection made encompasses all assets to be transferred as part of the process:

1. Cost of transferred assets model – in terms of this model, the original price of the assets, the balance of its original price (with regard to capital tax), its purchase value and the balance of its purchase value (with regard to real estate taxation) in the hands of the shareholder will be as they were in the hands of the closely held company had the asset not been transferred, all pro rata to the shareholder’s holding of shares in the company. In other words, under this model, the shareholders step into the shoes of the company.

2. Cost of shares model – the original price of each asset to be transferred to the shareholders will be calculated as a multiplier of the original price of the shares of the closely held company in the hands of the shareholders in the ratio between the value of the specific asset being transferred and the value of all assets being transferred on the date of transfer, all pro rata to the shareholder’s holding of shares in the company. Nevertheless, to the extent the asset to be transferred is depreciable, depreciation will be accorded based on the balance of the original price in the hands of the closely held company as opposed to the remainder of the depreciation period attributable to the asset then in the hands of the company.  In other words, in such case, the shareholder steps into the shares of the company for the purposes of future depreciation.

The date of acquisition of the asset being transferred will be based on the date of its acquisition as it was in the closely held company, regardless of the option that is ultimately chosen with regard to the cost of the asset to be transferred.

1. Liquidation of a closely held company in a chain of companies

The Temporary Provision also addresses the possibility of liquidating a closely held company within a chain of companies, namely, a closely held company that is not held directly by an individual shareholder, the foregoing subject to satisfaction of the following conditions:

• The holders of rights in the company submitted to the General Director of the ITO a declaration, stating that the transfer of assets to a company directly holding the closely held company was done as part of a comprehensive plan where ultimately all the assets will be transferred to an individual.
• The plan will be completed and all chargeable tax will be paid by the end of the 2025 tax year.
• A guarantee will be furnished as security for payment of the tax, to the satisfaction of the General Director of the ITO or the assessing officer

It was clarified in the Circular that non-compliance with the aforesaid conditions will result in nullification of the reliefs and payment of the tax liability in full, together with interest and linkage differentials.

Moreover, the Circular describes various situations and contains examples of the liquidation of a closely held company within a chain of companies, while noting and highlighting unique provisions with respect to each of them.

The Asset Transfer Track

As stated above, the Temporary Provision offers far-reaching tax benefits also to shareholders wishing to “retrieve” assets from a closely held company held by them, even without opting for its liquidation.  The ITA accordingly clarifies in the Circular its stance regarding the conditions and tax implications for pursuing this track, as detailed below.

1. Conditions of the track
   • Identity of absorbing shareholders – transfer of the asset in accordance with this track will be effected to all the company’s shareholders pro rata to their respective rights therein or only to the company’s substantive shareholders (the rights will be transferred pro rata, based on their respective holdings of shares in the company).
   • Determination of original price and date of acquisition by shareholders – the balance of the original price of the assets being transferred, the balance of their purchase value and their date of acquisition by the shareholders will be as they were in the closely held company had they not been transferred to the shareholders.
   • Transfer of liabilities to shareholders – the Circular clarifies that, as a rule, the assignment of liabilities to the company’s shareholders will not be permitted, save for specific exemptions as enumerated in the Circular.
2. The tax implications

At the level of the transferring company

The transfer of assets to the shareholders should be perceived as a distribution carried out by the company in the amount of the balance of the original price or the balance of its purchase value, as applicable, which amount should be subtracted from the company’s retained earnings.  The Circular thus clarifies that to the extent a profit/loss is recorded in the books of the company following transfer of the asset to the shareholder, and to the extent there is subtracted from its profits an amount in excess of the balance of the net price, then such outcome should be disregarded for tax purposes.

At the shareholder level

Transfer of the asset will be calculated as a dividend in the hands of the shareholder in the scope of the balance of its original price or the balance of its purchase value on the date of transfer, as applicable, by deducting the balance of the loan from the financial institution (to the extent a pledge over the asset will be registered against it).  In this regard it should be clarified that a shareholder’s loss will not be recognized, also where the balance of the loan from a financial institution exceeds the balance of the original price of the asset being transferred or the balance of its purchase value.

To the extent the scope of the income attributable to the shareholder exceeds the amount of distributable profits of the distributing company, the balance of the aforesaid income can be subtracted from the balance of the specific right that was used to purchase the asset being transferred by 31 December 2024 (including a third party undertaking that was used directly for acquisition of the aforesaid asset).

Transfer of the asset under this track, which will result in a tax liability in the hands of the shareholder, exempts the company from its liability to pay tax in 2025 pursuant to the provisions of sections 81B and 81C of the ITO.  In other words, the company will not be required to distribute additional dividends to its shareholders in 2025 in order to avoid the imposition of “additional tax” in the rate of 2% on its accumulated retained earnings.

1. The tax liability on a future sale of assets that are transferred by the shareholder

The Temporary Provision seeks to create tax continuity by a distribution of profits created through the periodical realization of assets by shareholders, such that for the period commencing on the date of acquisition of the asset by the company and ending on the date of its transfer to the shareholder under the Temporary Provision (“the First Period”) a two-stage taxation will be imposed and for the remainder of the period, namely, the period commencing on the date of transfer of the asset to the shareholder and ending on the date of realization (“the Second Period”) a one-stage tax rate will be imposed.

Accordingly, it is provided in the Circular that at the time of sale of an asset by the shareholder, a linear distribution will be carried out of the real capital gain accruing/appreciation that was generated, such that the profit attributable to the First Period will be subject to marginal tax pursuant to the provisions of section 121 of the ITO, while with respect to the profit attributable to the Second Period, the provisions of section 91 of the ITO and section 48 of the Real Estate Taxation Law will apply (one-stage taxation).  All the foregoing, save for inventory that is transferred to shareholders, with respect to which all accumulated profits will be subject to marginal tax.

The VAT Aspects in the Temporary Provision

 Detailed in the Circular are highlights and clarifications for the purpose of implementing the provisions of the Temporary Provision for VAT purposes, as outlined below:

• Transfer of real estate assets – the transfer of rights in land to a shareholder within the ambit of the Temporary Provision will attract zero-rated VAT.  On a future sale of a right in land by a shareholder, the full rate of VAT will apply, the foregoing even if the shareholder does not fall within the category of a “dealer” at the time of the sale.  This therefore speaks of a mechanism facilitating deferment of the VAT liability to the date of sale of the land by the shareholder.
• Transfer of other assets – the transfer of assets not constituting rights in land will attract the full rate of VAT on the date of transfer.  Thus, to the extent the shareholder is registered as a “dealer” for VAT purposes at the time of sale of the asset by him, he will be entitled to deduct input tax with respect thereto.
• Sales price of asset to shareholder –  the sales price of the asset (including rights in land) to a shareholder for VAT purposes will be the market value of the asset on the date of transfer.

The Land Taxation Aspects in the Temporary Provision

1. At the stage of the transfer of assets
   At the time of transfer of the rights in land or in a real estate corporation under the Temporary Provision, an appropriate report must be submitted to the relevant Land Taxation Department within the ITO, by means of a designated form.  In the report, it will be necessary to declare before the Land Taxation Manager due compliance with the conditions of the Temporary Provision, including reporting and payment of the chargeable tax.
2. At the stage of a future sale
   On the future sale of a right in land that is transferred to a shareholder under the Temporary Provision a mechanism ensuring tax continuity as described above will apply.  Nonetheless, the Circular emphasizes that if on the date of transfer to the shareholder the property being transferred does not fall within the definition of a “residential apartment”, as stated in section 1 of the Real Estate Taxation Law, then, on the date of sale of the property in the future by the shareholder, the exemption accorded to a “qualifying residential apartment” will not apply, the foregoing even if on the date of sale the property was compliant with the conditions of the ITO in this regard.  Moreover, the Circular provides that in the event of a future sale, it will not be permissible to deduct from the appreciation the payment made pursuant to the Temporary Provision.

* The newsflash is intended to provide subscribers with general information only and should not in any way be regarded as firm professional advice and/or a definitive legal opinion.