Should my Israeli company elect family company status if I live abroad?

Most foreign owners of a small Israeli company are told about the 23% corporate rate and the second layer of tax on dividends, and stop there. There is a third option that Israeli accountants use constantly and rarely explain to overseas clients. Under Section 64A of the Income Tax Ordinance a qualifying company may be treated as a chevra mishpachtit, with its taxable income and capital gains attributed to a single shareholder, the representative taxpayer, and taxed as that person's income.

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Detailed Answer

The mechanics are unusual and worth stating plainly. The company keeps its separate legal personality, files its own return and holds its own assets, but for tax purposes the profit is treated as the representative taxpayer's own income and is taxed at that individual's marginal rate, using that individual's credits, losses and exemptions. Distributions of profits that were already taxed in the representative taxpayer's hands are not taxed again as a dividend. Eligibility is narrow: the shareholders must all be relatives within the meaning of the section, and the election must be filed with the assessing officer no later than one month before the start of the tax year to which it applies, or within three months of incorporation for a new company. The Israel Tax Authority set out its current reading of both Section 64 house companies and Section 64A family companies in Professional Circular 02/2019, published after Amendment 245 to the Ordinance rewrote this area, and the circular is the practical reference an Israeli accountant will work from. Note the trap on exit: a family company that ceases to qualify, or that revokes the election, cannot simply switch back, and the consequences of losing the status mid-stream are usually worse than never having elected.

Where this matters to a shareholder abroad is in the identity of the representative taxpayer. Israel taxes non-residents on Israeli-source income, and a number of exemptions available to a non-resident individual, most visibly on gains from tradable Israeli securities, are not available to an Israeli company. Attributing the company's income to a non-resident representative taxpayer can therefore change the answer rather than merely shift the timing, which is precisely why the Tax Authority scrutinises these structures. It also imports the representative taxpayer's home-country reporting: a US or French shareholder who becomes the taxable person for an Israeli entity's income must reconcile that with their own controlled-foreign-company and disclosure rules, and the two systems will not agree about when income arises. The election, the appointment of the representative taxpayer and the annual return can all be handled by an Israeli accountant under a notarised and apostilled power of attorney, but the decision is not one to take from a summary. If the immediate question is what to do with profits already sitting in the company, our answer on tax on retained earnings in an Israeli company held by a non-resident covers the distribution side.

In Practice: Section 64A of the Income Tax Ordinance [New Version] 5721-1961 attributes a family company's income and capital gains to the representative taxpayer, taxed at that person's rates, with previously taxed profits distributed free of further dividend tax. The election must reach the assessing officer at the Israel Tax Authority no later than one month before the start of the tax year, or within three months of incorporation; the Authority's reading appears in Professional Circular 02/2019 following Amendment 245. Ordinary corporate tax is 23% and dividend withholding 25% or 30% under Section 125B, so on annual profits of NIS 500,000 the two-layer route costs roughly NIS 200,000 before treaty relief, which is the number the election is measured against.

When to Consult a Lawyer

• Your shareholders are relatives but not all within the statutory definition. The election is refused or later unwound, and an unwound family company is taxed as an ordinary company for the whole period with interest running.
• You are a US person. Family company status makes you the taxable person for the entity's income in Israel while the US continues to treat the company under its own rules, and the credit position has to be modelled before the election, not at the first filing.
• The company holds Israeli real estate. The interaction between Section 64A and the Real Estate Taxation Law is not intuitive, and a structure that saves tax on rent can cost far more on an eventual sale.

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Speak With an Israeli Attorney

We model the family company election against ordinary corporate taxation for your actual profile, check that your shareholders qualify, and file the election inside the statutory window so the option is not lost for a full tax year.

Contact us for a confidential initial consultation.