Global Tax Alert | 19 September 2017

Israel: Intercompany balances can trigger dividend taxation at 31 December 2017

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Executive summary

On 23 August 2017, the Israeli Tax Authority (the ITA) published a formal circular on the taxation of shareholders upon withdrawals from a company (the Circular). The Circular explains the application of Section 3(i1) of the Israeli Tax Ordinance which entered into force on 1 January 2017.

Under Section 3(i1), a direct or indirect withdrawal of funds from a company (including loans or any other debt) can be viewed as taxable income in the hands of a substantial shareholder. This can apply to both Israeli and non-Israeli resident companies and shareholders.

Income from the withdrawal of funds will generally include the total direct and indirect withdrawals at the time of the taxable event, minus amounts returned to the company by that date (as long as such funds are not re-withdrawn later). The time of the shareholder’s taxable event will be the end of the tax year immediately following the year in which the funds were withdrawn. As a transition measure for the first year, withdrawal balances recorded as of 31 December 2016 may be taxable in the hands of the shareholder on 31 December 2017, unless the funds were returned to the company by such date. Companies with a non-calendar tax year should examine their specific implications.

Income generated under Section 3(i1) will generally be classified as a dividend, but may alternatively be treated as employment income or business income in certain cases. If considered a dividend, the applicable statutory tax rate is generally 30%, but may be reduced if the company has earnings subject to tax incentives in Israel (such rates vary from 4% to 20%, depending on the relevant tax incentive program). Dividend tax rates may also be reduced under an applicable tax treaty.

Notably, the ITA clarified that where certain conditions are met, qualifying loans may not be considered withdrawals, to the extent they are provided indirectly and used for business purposes. Such indirect loans can be, for example, a loan between sister companies or a shareholder withdrawal from an indirect subsidiary. Moreover, a cumulative withdrawal amount of under ILS100,000 (approx. US$30,000) would generally not trigger taxation under Section 3(i1).

In light of this development, shareholders of Israeli companies should review intercompany balances over ILS100,000 that were withdrawn from the company (or from its subsidiaries) by 31 December 2016. Careful consideration should be given to the new law provisions, as this can result in a potential dividend tax liability as of 31 December 2017.

Detailed discussion

Definition of “withdrawal from a company”

Section 3(i1) covers two scenarios: (a) a withdrawal of funds from a company by a substantial shareholder; and (b) making use of a company’s asset by the shareholder (in both scenarios, either directly or indirectly).

The definition of withdrawal of funds from a company covers any loan, including borrowings and any other debt. The definition also includes guarantees made to the benefit of the shareholder.

A shareholder for this purpose is a substantial shareholder (generally holding 10% or more in the means of control) or a related party. Importantly, no distinction is made between Israeli and non-Israeli resident shareholders.

It should be noted that making use of a company asset relates only to individual shareholders and may be considered a withdrawal only where the relevant asset falls within an exhaustive list of assets (e.g., an apartment, art work, aircraft, etc.). Therefore, corporate shareholders will be generally impacted by Section 3(i1) only in cases of withdrawals of funds. Moreover, provisions of Section 3(i1) may generally not apply to an Israeli shareholder subject to Israeli corporate income tax and who is making a withdrawal from an Israeli company.

Indirect withdrawals

A withdrawal can be done indirectly. An example provided in the Circular is a shareholder who withdraws funds from a subsidiary down the chain (i.e., and not from the company held directly by the shareholder). Another example is in the case of a loan provided by a company held by the shareholder, to a company also held by that same shareholder (e.g., sister companies).

Notably, a specific exception is that a loan provided to a non-transparent company for business purposes would not be considered an indirect withdrawal. Such indirect loan would not be subject to potential reclassification as a dividend. However, the Circular clarifies that this relief would not apply to a withdrawal performed without a loan agreement, including a set interest rate, repayment schedule, and borrower’s securities.

Classification of income

At the time of the shareholder’s taxable event, shareholder income from a withdrawal will be classified as follows:

1. In the first place, a dividend classification will apply, but only to the extent there are earnings in the company from which the funds were withdrawn. With respect to a would-be indirect withdrawal from a chain of companies (e.g., a parent company and a subsidiary) the amount of earnings should be tested on a consolidated basis.

2. To the extent there are no earnings, the income would be classified as either employment income, or as business income, depending on its nature. These alternatives will not apply to a shareholder who is either an Israeli company subject to corporate income tax, or a non-Israeli non-transparent company.


Shareholders of Israeli companies should review intercompany balances over ILS100,000 that were withdrawn by 31 December 2016 and would not be repaid by 31 December 2017, and carefully consider the applicability of Section 3(i1).

For additional information with respect to this Alert, please contact the following:

EY Israel, Kost Forer Gabbay & Kasierer, Tel Aviv
  • Sharon Shulman
    +972 3 568 7485
Ernst & Young LLP, Israel Tax Desk, New York
  • Rani Gilady
    +1 212 773 9630

EYG no. 05321-171Gbl