Corporate taxation

A common way to operate a business worldwide is by creating a corporation. This is a separate legal entity to the owners (called shareholders), but is recognized worldwide. Corporations are often referred to as companies, and the two terms will be used interchangeably.

One of the major advantages of a corporation is that, except in the case of negligence on the part of the owners, the liability of the company is limited to the amounts of money that the owners invested into the company. This is where the concept of a “limited” company comes from. In Israel, all limited companies are known as בע”מ. In other countries, there is normally a distinction between a privately held company (“Limited” or Ltd) and one where the shares are traded on a stock exchange (“public limited company = plc”, Inc etc.)

Since the corporation is a separate legal entity, it is treated as such for tax purposes as well. For 2016, the rate of Corporation Tax (מס חברות) is a flat 25% on the taxable profit of the company. For these purposes, the profit of a company is after deducting all allowable expenses, including any and all salary expenses (subject to limits defined by law).

The residual profits, after paying tax, are then available to be used as seen fit by the directors, who are the people charged by the shareholders to look after the long-term interests of the company. So the profits can be reinvested, or paid out to the shareholders.

These payouts to shareholders are known as dividends. The dividends are not considered an expense for Corporation Tax purposes, but the shareholder has to pay tax on them. The rate of tax is determined by the percentage ownership that the shareholder has in the company, whilst taking into account the shares held by close family members. Those owning 10% or more (known as controlling shareholders) must pay 30% tax; those owning less pay 25%.

For controlling shareholders, the effective tax rate therefore comes to just under 50% (25% on company profits, and a further 30% on the residual profits) – which is similar to the top rates of income tax and Bituach Leumi combined. So there are minimal tax benefits to running your business as a company, rather than as an individual.

It should also be noted that there are a significant number of bureaucratic requirements of a company that do not exist when running a business as yourself or as a partnership. These include the requirement to have full double-sided bookkeeping, and the financial statements of the company must be audited by a Registered Auditor (a specialization within the accounting field) every year. It is important to note that in Israel, there are no exemptions for audits.

That being said, there can certainly be perfectly legitimate business and other reasons to operate as a business. But as with many other aspects to life, it is important to be aware of all of the issues so that you can make an informed decision.

Contact me today to discuss your personal business affairs, and to discuss whether it would be a wise move to incorporate your business.