LAST CHANCE TO TAKE ADVANTAGE OF THE TEMPORARY PROVISION PERTAINING TO A TRANSFER OF ASSETS FROM COMPANIES TO THEIR SHAREHOLDERS
At the beginning of 2025, a reform on the taxation of undistributed profits within the ambit of the Economy Efficiency Law (Taxation of Undistributed Profits), 5785-2024 entered into effect, which established a new mechanism entailing the imposition of an additional 2% tax on undistributed profits in the hands of closely held companies, in order to limit the utilization of companies for tax deferment purposes and foster dividend distribution.
Within the context of the tax newsflash that was published in January 2025, we extensively covered the provisions of the comprehensive reform that was underway in the corporate tax regime, its diverse and far-reaching implications, including the beneficial temporary provision inherent therein. As explained by us, the temporary provision facilitates the liquidation of a closely held company or the “removal” and transfer of assets held by it to its shareholders, while receiving a significant tax benefit.
Consequently, in the tax newsflash for April 2025 (to read), we reviewed Income Tax Circular 03/2025, which clarified the conditions of the temporary provision.
We wish to remind you that, the validity of the temporary order expires at the end of November 2025. The Israel Tax Authority (the ITA) has clarified more than once that the validity of the temporary provision will not be extended. Accordingly, taxpayers wishing to enjoy the tax benefits conferred on the strength of it should act as soon as possible to implement it.
TAXATION OF UNDISRIBUTED PROFITS – IMPORTANT CIRCULARS PUBLISHED BY THE ITA
On 19 October 2025, the ITA published two supplementary Circulars on the reform pertaining to the taxation of undistributed profits. The Circulars – Income Tax Circular 7/2025 and Draft Income Tax Circular 8/2025 – are designed to clarify actual implementation of the provisions of the law: the first focuses on a mechanism for calculation of the profits and income over which the additional tax is to apply, and the second delineates the boundaries of the term “closely held company”, over which the reform has application.
Income Tax Circular 7/2025 – Implementation Clarifications
Income Tax Circular 7/2025 addresses the implementation of sections 81A-81F of the Income Tax Ordinance [New Version] 5721-1961 (the ITO), and details the manner of calculation of the accumulated profits and surplus profits, over which the additional tax is imposed, and also provides important clarifications with regard to actual implementation of the law and its interpretation.
Principal clarifications included in the Circular:
- Calculation of profits for “veteran )i.e., long-established) companies” – with respect to companies incorporated prior to 1996, that have difficulty in calculating the accumulated profits due to a lack of historical documentation, it provides that reliance can be made on the accounting surplus balance for 1995 as a starting point for calculating the accumulated profits. The Circular thus declares that with respect to veteran companies, calculation of the profits will be possible even in the absence of complete data, as the working assumption is that for the purpose of calculation of the accumulated profits under the taxation track, the surplus balance for 1995 can be regarded as referring to the total profits from the date of incorporation of the company until such date.
- Undistributed dividends – the Circular clarifies that a declared but undistributed dividend will be deducted from the accumulated profits only if tax is paid for it or if it is actually distributed within 12 months from the date it is declared or until the date of submission of the annual financial statements – whichever is the earlier. In this way, the possibility of deducting “paper” profits from unpaid dividends is circumvented.
- Special assets – customer balances and upfront expenses – the Circular broadly addresses the issue of the classification of certain assets as “special assets”, where the moneys invested in them constitute surplus profits, as distinct from an investment in operating assets. Thus, it provides that customer balances deriving from the ongoing business activities of the company will not be deemed a “special asset”, save in circumstances where the balance bears the characteristics of a loan (such as an unusual credit period, interest, linkage or collateral). In that same context it provides that upfront expenses are not considered a special asset, as long as they derive from current expenses or from an acquisition of assets that do not constitute special assets. On the other hand, upfront expenses directly relating to a special asset – for example, payment to a contractor for renovating a property that is leased to third parties – will be classified as constituting part of a special asset. It should be recalled that a determination providing that surpluses in respect of these assets do not constitute a special asset exceeds the scope of the applicability of the 2% additional tax thereon.
- Equity profits – when calculating accumulated profits in the accounting alternative, equity profits or losses as recorded in the books of the closely held company (and with respect to equity profits – provided they were not yet distributed as a dividend to the closely held company by companies held by it), will be neutralized, the foregoing out of a desire to prevent a recount of those profits or losses.
Draft Income Tax Circular 8/2025 – definition of “closely held company”
The Draft Circular deals with the interpretation of section 76 of the ITO, with its purpose being to hone the boundaries of the definition of the term “closely held company” – a company controlled by a maximum of five shareholders, without the public having any real interest in it.
Principal clarifications included in the Draft Circular:
- Control by means of options and circumventing dilution of the nucleus of control – when examining the control in a company, there should also be considered the rights to purchase shares (such as options), the foregoing to the extent that their realization may result in five individuals or less attaining control by one of the means of control. Concomitantly, it provides that when examining the control, there should not be taken into account the potential dilution of existing shareholders. In other words, even if options exist that could lead to dilution of the controlling shareholders, this should not be deemed as negating the existence of the nucleus of control for the purpose of classifying the company as a closely held company. This speaks of anti-planning provisions whose purpose is to circumvent the artificial splitting of holdings and indirect control. In our view, the aforesaid provisions contradict one another and it may be assumed that they could serve as a basis for controversy between taxpayers and the ITA.
- Attributing relatives and trusts – for the purpose of counting the nucleus of control, a person and his relatives, a person and his lawyer/agent, partners in a partnership, members of a Kibbutz or a collective settlement, as well as a trustee, the settlors of the trust and beneficiaries thereunder – will all be considered as one person. Thus, the ITA wishes to impede the splitting of control by means of familial or trust structures.
- Companies in which the public has a real interest – the Circular clarifies that a public company, a company in which more than 25% of its shares are held by a public company, a public institution, a local authority, a provident fund or a governmental company – will not be regarded as a closely held company. On the other hand, a private company that issued bonds to the public but whose shares are not listed for trade on a stock exchange, or a company that is held by institutional investors only, will still be regarded as a closely held company.
The two published Circulars illustrate practical implementation of the reform as well as the tendency of the ITA to clarify the boundaries and manner of its actual application.
PUBLICATION OF A DRAFT BILL FOR IMPLEMENTATION
OF THE PILLAR TWO RULES IN ISRAEL
On 5 October 2025 the Ministry of Finance published a draft bill bearing the proposed title “Minimum Corporate Tax on a Multinational Group Law, 5786-2025” (“the Draft Bill”), with the aim of implementing the global minimum tax rules (Pillar Two) in Israel. The Draft Bill constitutes a significant step in conforming the Israeli tax system to existing international standards as prescribed by the OECD.
The Pillar Two Rules (“Pillar 2”) constitute part of the OECD’s BEPS project, that seeks to ensure that large multinational corporations will pay an effective minimal 15% tax on the profits reaped by them in every country in which they operate. In this way, the OECD wishes to thwart a “spillover” of profits from high-tax countries to countries in which relatively lower tax rates apply.
Key Mechanisms included in Pillar 2
The Pillar 2 model depicts three principal mechanisms for imposition of a top-up tax in circumstances where the effective tax rate in a particular country is less than 15%:
- The IIR (Income Inclusion Rule): this mechanism places liability for imposition of the top-up tax on the ultimate parent entity (UPE) of the multinational group. Thus, where the company operating in the foreign country is liable for the effective tax in a rate less than 15%, the parent company will be liable for the top-up tax in its country of domicile.
- The UTPR (Undertaxed Profits Rule): this speaks of a top-up mechanism and substitute for the IIR. Thus, in cases where the top-up tax is not imposed by means of the IIR (for example, where the country of domicile of the parent company has not adopted the rules), the UTPR enables other countries that have adopted the rule to impose the top-up tax. It does so by withholding deductions or demanding that other subsidiaries in the group operating in those countries make conforming adjustments, until the required top-up tax is collected.
- The QDMTT (Qualified Domestic Minimum Top-Up Tax): this is the mechanism that is relevant for the purposes of the Draft Bill that was published in Israel. The QDMTT mechanism grants the originating country (the country in which the activity is carried out) a first right to collect the top-up tax itself, the foregoing with respect to companies where the effective tax rate attributable to their profits is less than 15%.
The Draft Bill and Adoption of the QDMTT in Israel
At this stage, the Draft Bill is adopting only the QDMTT mechanism (implementation of the additional mechanisms mentioned above will be re-examined in the future). The proposed law applies to Israeli resident entities that are members of a multinational group whose operational global group turnover is €750 million or more, the foregoing effective as of 1 January 2026.
As noted above, the QDMTT is expected to be implemented in Israel only with respect to companies that are members of multinational groups and the effective tax rate to which they are subject is less than 15%. Accordingly, most companies in the Israeli economy, that are currently subject to a higher corporate tax rate (23%) will find themselves excluded from application of the proposed law. Nevertheless, many companies in the Israeli economy enjoy significant tax benefits, largely by virtue of the Encouragement of Capital Investments Law, 5719-1959, which may reduce the effective tax rate to which they are subject below the 15% threshold. Accordingly, we recommend that management in companies over which the QDMTT mechanism is expected to apply, examine in advance how they may be impacted by application of the proposed law and prepare accordingly, the foregoing prior to the proposed law entering into effect.
To conclude, we would add that, alongside the Draft Bill, the Ministry of Finance recently announced its intention to publish an array of incentives in conformity with the Pillar 2 rules, so as to maintain Israel’s competitive edge in attracting foreign investments.
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Advs. Leor Nouman and Moti Saban from our Tax Department are at your service to answer questions regarding these updates and other tax-related issues.
* 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.
