Israeli Withholding Tax on Payments to Non-Residents

Picture an inventor in Toronto who licenses a patent to an Israeli technology company. The royalty is agreed at NIS 500,000 a year. When the first payment lands, it is short by NIS 115,000. The Israeli company has deducted tax at source and remitted it to the state, exactly as the law required, and no one warned the inventor in advance. He is now staring at a 23% bite he believed a tax treaty had eliminated, and the money is already gone to the Israel Tax Authority.

This is one of the most common shocks non-residents experience when money flows out of Israel. The country operates an aggressive deduction-at-source regime, and the burden sits on the Israeli payer, not on you. If the payer gets it wrong, the payer pays. So payers withhold first and ask questions later, which means the responsibility for securing the correct, lower rate quietly falls on the non-resident who is owed the money. Understanding the mechanism is the only way to keep your funds from being parked with the tax authority for months.

The Rule That Drives Everything: Section 170

Section 170 of the Income Tax Ordinance 1961 imposes a duty on any person paying income to a foreign resident to deduct tax at source on any amount chargeable to Israeli tax. It works alongside Section 164, the general withholding provision, but Section 170 is the one aimed squarely at payments leaving the country.

The logic is straightforward from the state's point of view. Once a payment reaches a non-resident abroad, Israel loses practical ability to collect. So it collects at the choke point, before the money crosses the border, and it makes the Israeli payer answerable for getting it right. A foreign resident's Israeli-source income, whether dividends from an Israeli company, interest on an Israeli loan, royalties for use of an Israeli-licensed right, or fees for services with an Israeli source, can all fall within the net.

This is the payer-side companion to the rules we cover in Israeli income tax for non-residents, which looks at the same income from the recipient's perspective. Here the focus is the deduction machinery itself.

The Default Rates Your Payer Must Apply

Absent a certificate authorizing something lower, the payer applies the statutory default. The headline figures are these:

• Dividends: 25% to a foreign individual, and 30% where the recipient is a substantial shareholder holding 10% or more of the company's means of control.
• Interest: generally 25% to a foreign individual, and the corporate rate, currently 23%, where the recipient is a foreign company.
• Royalties: typically the corporate rate of 23% for a foreign company, and up to 25% otherwise.
• Services and other income: a default of 25%, subject to the specific deduction regulations for the category of payment.

These are not small numbers against a large payment. On an NIS 2,000,000 dividend to a 10% shareholder, the default 30% deduction is NIS 600,000 held back at source. Whether you ever see a shekel of that again depends entirely on what you arranged before the money moved.

In Practice: Under Section 170 of the Income Tax Ordinance 1961, an Israeli company distributing an NIS 1,000,000 dividend to a non-resident must withhold NIS 250,000 at the default 25% rate, or NIS 300,000 if the recipient holds 10% or more of the company. The Israel Tax Authority (Rashut HaMasim) will not allow the bank to remit at a lower treaty rate without a withholding certificate (ishur nikui mas bemekor) issued by the assessing officer (pakid shuma), which typically takes three to eight weeks to obtain. Apply before the distribution is declared, not after, or the cash is locked up until a refund claim is processed.

Why the Treaty Rate Is Not Automatic

Here is the point that trips up almost everyone. Israel has tax treaties with more than fifty countries, and many of them reduce withholding on dividends, interest, and royalties to a band between 0% and 15%. A US resident, for example, may be entitled to a reduced dividend rate under the US-Israel treaty. But the treaty rate is a right you must claim, not a setting the payer can flip on.

An Israeli payer or bank cannot, on its own authority, decide that a treaty applies and remit accordingly. If it did and the analysis turned out to be wrong, the payer would carry the shortfall. So Israeli banks and companies will not apply a reduced rate without one of two things in hand: a withholding certificate from the assessing officer fixing the rate for that payment, or an approved declaration under the regulations governing transfers abroad, supported by documentation that the recipient is the beneficial owner resident in the treaty country.

Most treaties condition the reduced rate on beneficial ownership. A conduit entity inserted to capture a treaty rate will not qualify, and the Israel Tax Authority scrutinizes structures that look designed for exactly that. Expect to prove residency with a certificate from your home tax authority and to show that you, not an intermediary, are the true owner of the income.

In Practice: To release funds abroad at a reduced rate, the Israeli bank relies on the Income Tax Regulations governing deduction from payments to foreign residents. For many transfers it will accept a declaration form reviewed by an Israeli accountant or lawyer, but for dividends, interest, and royalties it usually insists on a withholding certificate from the assessing officer (pakid shuma) at the Israel Tax Authority (Rashut HaMasim). Budget three to eight weeks for the certificate and gather a current residency certificate from your home tax authority first, because the file will not move without proof of beneficial ownership in the treaty state.

The Two Roads to the Correct Rate

There are only two ways to end up paying the right amount rather than the default.

Before payment, secure a certificate. This is the road worth taking whenever the sum is significant. Your Israeli adviser applies to the assessing officer for a withholding certificate that sets the treaty or exempt rate for the specific payment. The payer or bank then deducts at that rate and remits the rest to you. Your money is never tied up, and there is nothing to reclaim.

After payment, file for a refund. If the full rate was already withheld, the non-resident can file an Israeli tax return claiming the over-withheld amount back. This works, but it is slow, it requires registering with the tax authority and filing in Hebrew, and the refund can take many months to arrive. You are effectively giving the state an interest-light loan in the meantime.

For a non-resident coordinating from abroad, the certificate route also avoids a practical headache: filing an Israeli return from overseas means appointing a local representative, dealing in Hebrew documents, and tracking a refund across time zones. Arranging the certificate in advance through an Israeli lawyer or accountant sidesteps all of it.

When the Payer Gets It Wrong

The deduction obligation is the payer's, and so is the risk. A company that pays a non-resident gross, without deducting, does not shift the problem onto the recipient. Under Section 170, the payer who fails to withhold is treated as if it owed the tax itself and becomes liable for the amount, with interest, CPI linkage, and penalties on top.

That single feature explains the behavior non-residents find so frustrating. An Israeli company will freeze a payment, demand documentation, and refuse to release funds until the withholding position is nailed down, because the alternative is paying your tax out of its own pocket. It is not obstruction. It is self-protection written into the statute.

Common Mistake: Non-residents negotiate a payment "net of tax" or assume a treaty automatically zeroes the deduction, then discover the Israeli payer has withheld at 25% or 30% because no certificate was in place. Recovering an over-withheld NIS 250,000 then means filing an Israeli tax return from abroad and waiting six months or longer for the Israel Tax Authority to process the refund, often with linkage but limited interest. Arranging the withholding certificate before the payment is declared avoids the entire delay.

A Note on Currency and Timing

Withholding is calculated and remitted in shekels, and the payment to you is usually converted at the time of transfer. Exchange-rate movement between the date tax is withheld and the date you receive the net sum is your exposure, not the payer's. For large or recurring payments, royalty streams or annual dividends in particular, it is worth fixing the certificate to cover the period rather than re-applying for each tranche, which the assessing officer can accommodate in appropriate cases.

Practical Checklist

• Identify the category of your income early, because dividends, interest, royalties, and service fees each carry different default and treaty rates
• Obtain a current tax-residency certificate from your home authority before anything else, since no reduced rate moves without it
• Apply to the Israel Tax Authority assessing officer for a withholding certificate before the payment is declared or transferred
• Be ready to evidence beneficial ownership, not just residency, especially where an entity sits between you and the income
• If tax was already over-withheld, register and file an Israeli return to reclaim it, and expect a multi-month wait
• Keep the certificate, the bank remittance advice, and proof of tax withheld for your home-country foreign-tax-credit claim

Speak With an Israeli Attorney

If you are about to receive a dividend, royalty, interest payment, or service fee from an Israeli source, the time to act is before the money moves, not after it has been withheld. We obtain withholding certificates from the assessing officer, document beneficial ownership to treaty standard, and coordinate with the paying company or bank so your funds leave Israel at the correct rate the first time.

Contact us for a confidential initial consultation.