Several significant changes to the Israeli Income Tax Ordinance came into effect at the beginning of 2025. These changes include a freeze on index adjustments, modifications to the taxation of closely held companies, and the introduction of an additional surtax on capital sources. This update includes an overview of the key changes and their impact on various groups.
Main affected groups:
These legislative changes are particularly relevant to the following groups:
- Israeli Residents: The amendments apply to all Israeli residents who are not exempt from income tax.
- Trusts Holding Israeli Companies: Trusts that hold shares in Israeli companies are affected by the new rules.
- Offshore Assets: The geographic location of the assets is irrelevant. Israeli residents will be subject to taxation even if their accounts are held abroad. Similarly, the rules on undistributed profits apply to Israeli companies with all assets (financial or otherwise) located outside Israel.
- Excluded from these changes: Returning residents, New immigrants, Controlled Foreign Companies and Partnerships, with respect to non-Israeli income/assets.
Freeze of Tax Bracket Adjustments:
From 2025 to 2027, adjustments to income tax brackets, credit points, and other allowances that were previously indexed to the Consumer Price Index will be suspended. This freeze, designed to reduce budgetary pressure, means that:
- Tax brackets and allowances for 2025-2027 will remain at 2024 levels.
- The adjustments will resume in 2028, accounting for inflation changes from 2027 onward.
This measure is expected to increase government revenues by maintaining effective tax rates despite inflation, impacting both individuals and businesses (not corporations).
Surtax on Capital Sources:
High-income earners will face an additional surtax on capital sources[1]. Currently, individuals with taxable income exceeding ILS 721,560 are subject to a 3% surtax. The new amendment introduces an additional 2% surtax specifically for capital resources above this threshold. In summary:
- Income from dividends, interest, real estate sales, and other capital sources exceeding ILS 721,560 will now incur a total surtax of 5%.
Changes to closely held companies (“Wallet Companies”):
Closely held companies often used by professionals to benefit from lower corporate tax rates, are facing stricter regulations to prevent perceived tax avoidance. Key changes include:
- Income Attribution:
A more significant portion of income from such companies will now be taxed directly as the personal income of the shareholders.
This includes income from professional services rendered by the individual shareholder.
2. Additional Tax on Undistributed Profits in Closely Held Companies
Closely held companies retaining substantial profits rather than distributing them to shareholders will now face a 2% penalty tax on undistributed earnings. Exceptions include:
- Companies with documented losses exceeding 10% of retained earnings.
- Companies that distribute at least 50% of their retained earnings as dividends.
- Companies meeting a 6% distribution rate relative to retained earnings.
Conclusion
These updates represent significant shifts in Israel’s taxation landscape, with implications for both individual and corporate taxpayers. Stakeholders managing investments or financial interests connected to Israel should review their structures and strategies to ensure compliance and optimize tax efficiency.
For further guidance, please feel free to contact us.
[1] Capital sources – Income that was not generated from individual work or business, including income from dividends, interest, capital gains, rental fees, and from the sale of real estate rights.
The content in this communication is provided for informational purposes only and is not intended to be comprehensive. It does not serve to replace professional legal advice required on a case by case basis.
