Deputy AG: Tax Benefit for Wealthy Firms Raises Legal Issues

Recommends that the tax be no less than 7.5% and suggests demanding companies utilizing the benefit to invest their resulting savings in Israel.

Deputy Attorney General Avi Licht warns that granting profligate tax benefits to some of largest and wealthiest companies doing business in Israel on their "trapped" profits could lead to sticky legal complications. The Finance Ministry is asking for the government's go-ahead in a bid to tap some of the unused and untaxed profits sitting in the coffers of those companies by enticing them to release the funds.

These so-called trapped profits, totaling NIS 120 billion, were accumulated through benefits enjoyed by the companies over the years under the Encouragement of Capital Investments Law. Owners of the companies have been leaving the profits untouched to avoid suffering any tax liability - either through reduced corporate taxes or via the reduced tax on dividend distributions deriving from such earnings.

Finance Minister Yuval Steinitz now estimates that NIS 3 billion in taxes can be collected from this source by the end of 2013. Previous treasury estimates had run between NIS 1 billion and NIS 3 billion.

The treasury's new bill would extend substantial tax benefits to the companies, allowing them to distribute the money as dividends while being taxed at a relatively low rate - but no less than 6%, the lowest future threshold rate under the new capital investment incentive law. Under the proposal, the rate of the benefit will be linked to the size of the dividend payment, becoming increasingly larger the more the company pays out. The offer will hold for a year, any company accepting it will need to complete the process within 30 days of announcing it and it cannot be canceled. The treasury recommends that the proposal go into effect during the 2012 tax year.

Licht had several reservations to the treasury's proposal. He recommends that the tax be no less than 7.5% and suggests demanding companies utilizing the benefit to invest their resulting savings in Israel - as opposed to the treasury which doesn't currently recommend requiring any local investment whatsoever. Licht also suggest making use of the benefit conditional on the company switching to a regime in which it pays corporate taxes in the year the income is earned. Companies would pay tax at the applicable rate at the time of the dividend distribution. If the applicable tax rate under the new capital investment encouragement law is lower than that, however, the lower rate would apply.

Licht justified the proposal by citing the situation that has developed, whereby companies enjoying benefits have an incentive not to distribute dividends and thereby avoid paying any tax - with the state unable to do anything about the matter.

"Granting an additional tax benefit to companies that already benefit, including some of the largest and wealthiest companies in the economy, by temporary order and at the present time raises legal difficulties, even if such difficulties aren't sufficient to constitute a true legal barrier," said Licht.

The difficulties, according to him, arise from a situation of inequality vis-a-vis other sectors: companies that have chosen other benefits schemes or companies that already distributed dividends and might have acted differently had they known there would be a change in taxation. Licht added, however, that there is a legal answer to these difficulties, particularly considering the fact that individuals and enterprises haven't inherent rights that prevent any future changes to tax policy.