Tax Authority Re-evaluates Undistributed Profits Reform

The undistributed profits reform is emerging as the highlight of the current government's tax policy. Initially proposed as part of austerity measures, it was backed by months of professional work and a structured economic rationale. The success of the reform surprised even its architects, as state treasury revenue reached double the initial estimate.

However, it may have succeeded too well. The law exempts companies that purchase land, build, and sell from corporate tax, but taxes companies that purchase and rent out real estate. This skews the market, as firms prefer to build and sell rather than invest in income-producing real estate, particularly in the office sector, which is at risk of cooling down more than desired.

Therefore, the Tax Authority has announced a re-examination of the reform, which Globes has learned will take place as part of the upcoming Economic Arrangements Law. Solutions being considered include providing relief for companies to invest in office real estate, though the issue remains under discussion.

Implementation Challenges

Implementation is expected to face significant hurdles. State revenues currently rely on this tax as the debt-to-GDP ratio has climbed to 70% and interest payments are straining government spending. With the defense budget having nearly tripled, the 2027 budget is expected to include harsh tax measures. Professional assessments suggest that if changes are made, priority will be given to easing the burden on working individuals rather than capital owners.

Roots of the Reform

In late 2024, a team led by then-Director General of the Ministry of Finance Shlomi Heisler proposed recommendations based on Israel's two-stage tax structure. The goal was to equalize tax rates for high-income individuals (around 50%) and incentivize companies to invest in economic activity rather than using "wallet companies" for passive accumulation.

Previously, this mechanism was used for unlimited tax deferral. Findings showed that 20% of the economy's undistributed profits were locked in these companies, resulting in an estimated annual revenue loss of 5–6 billion shekels. Last year, tax collection rose by 14%, with total revenue from the reform reaching 15–20 billion shekels.

Stakeholder Perspectives

The current law requires companies to distribute accumulated profits or pay a 2% "tax penalty." Controlling shareholders of wallet companies with turnover up to 30 million shekels must pay a marginal tax on undistributed profits exceeding 25% of turnover.

Finance Minister Bezalel Smotrich has acknowledged the need for adjustments in the real estate sector, stating that the goal was not to suppress economic activity. Shlomi Heisler, who led the reform, also noted that while it successfully closed legitimate tax planning loopholes, the real estate investment aspect requires further refinement.

Tomer Tzaliah, Vice President of the Contractors Association, notes that the expectation for withdrawn funds to be invested in apartments did not materialize due to purchase taxes, adding that the negative impact is most visible in the rental market.