Personal services corporations have distributed NIS 40 billion in dividends this year, with the money going to the individuals who own these corporations, who have taken advantage of a tax benefit granted by the Israel Tax Authority, the Ministry of Finance says. Under an administrative order that expired after the Yom Kippur holiday, controlling shareholders of personal service corporations were able to withdraw dividends from their companies at a reduced 25% tax rate, compared with the regular 33% rate (including 3% surtax).
The administrative order was initiated by Tax Authority head Moshe Asher in agreement with the Institute of Certified Public Accountants in Israel, the Israel Bar Association, and the Institute of Tax Advisors in Israel. The order was included in the Economic Arrangements Law and approved by the Knesset Finance Committee. At the time it was approved, the Tax Authority estimated that NIS 4 billion would be withdrawn in dividends, but it emerged yesterday that the final amount is likely to be 10 times as much as expected.
This means that the tax benefits for controlling shareholders in personal service corporations who took advantage of the order are likely to reach NIS 3 billion, compared with NIS 300 million according to the statement by the Tax Authority when the order was approved. A personal service corporation is a company formed by a single person for tax planning purposes, or in order to pay less tax than the income tax levied on the taxpayer. A partner in a law firm, for example, may form such a company to receive his or her share of the firm's profit, thereby avoiding taxation at personal income tax rates. The owners of such companies are usually wealthy.
In response, the Tax Authority asserts that, without the administrative order, the money would have remained in the personal service corporations, as was previously the case. Asher confirmed the Ministry of Finance's statements to "Globes," saying, "The state got something it would not have received; this is not a benefit - it is an addition to the state's revenues. The order is the result of new tax rules for personal service corporations that cleared up many questions. People can benefit from the profit locked up in personal service corporations, and we have brought about a 'restart' for personal service corporations so that the owners will now be clear about what they ought to do."
The Tax Authority's measure generated a NIS 5.8 billion one-time tax revenue surplus in September, and the Ministry of Finance estimates that the state's one-time tax revenues will eventually exceed NIS 10 billion.
In the short term, the tax revenue surplus will help the Ministry of Finance pay for the increased benefits for disabled persons over the coming year. This is good news, given that a defense entity that was also to have paid the state billions of shekels is not doing so now because of legal difficulties, as reported yesterday by "Globes."
Why, then, is the Ministry of Finance so critical of the measure? First of all, it is feared that the enormous surplus will generate political pressure, especially by ministers, to use the surplus for political purposes at a bad time for the Ministry of Finance – on the eve of the upcoming cabinet decision about distribution of the 2018 budget reserves.
Secondly, the enormous tax revenue surpluses constitute a major tax benefit for owners of personal service corporations, who are usually extremely wealthy. The Ministry of Finance says that the tax benefit granted to them by reducing the tax rate on dividends was too big, and in any case greatly exceeded the estimates given by the Tax Authority when the state budget was being drafted.
Published by Globes [online], Israel Business News - www.globes-online.com - on October 3, 2017
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