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Taxation of Substantial Shareholders

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In 2024, as part of the Trapped Profits Law, significant changes were made to Section 62a of the Income Tax Ordinance, which relates to the taxation of substantial shareholders in closely held companies, or "wallet companies". These changes came into effect on January 1, 2025. Here's a comprehensive review of the main changes:

Expansion of the Section's Scope

  1. The section was expanded to include highly profitable closely held companies whose main income derives from active business activity with a significant personal effort component.

  2. New subsections (62a(a1)-62a(a3)) were added, expanding the scope of the section.

Changes in Service Provider Definition

    1. Shortening the examination period for the presumption of a wallet company:

  • Before the change: 70% of income from one client for 30 months out of 4 years.

  • After the change: At least 22 months out of 3 years.

    2. Elimination of the exception for attributing profits to a partner in a partnership.

Changes in Officer Definition

  1. Change in the exemption for shareholders:

  • Before the change: Exemption applied to owners of 10% or more of shares.

  • After the change: Exemption applies only to owners of 25% or more of shares.

Expansion of Income Attribution

  1. Expansion of income attribution to individual shareholders in closely held companies.

  2. Includes income from activities "rich in personal effort".

  3. Also applies to partnership profits held by closely held companies.

Effects on Wallet Companies

  1. Increased taxation on income derived from personal effort.

  2. Reduction of tax planning possibilities through wallet companies.

Exceptions

  1. The section does not apply to family companies, controlled foreign companies (CFC), and preferred/beneficiary/approved enterprise companies.

Tax Implications

  1. Income charged as taxable income of the shareholder will be recognized as an expense of the company.

  2. Section 62a(a) takes precedence over the new section 62a(a1) regarding marginal tax liability.

These changes represent a revolution in the taxation model of wallet companies in Israel, aiming to address aggressive tax planning and increase state tax revenues. It's important to note that the full effects of the change are still being examined, and further adjustments may occur in the future.