However, there is the option – under certain circumstances – for the income to be taxed directly in the hands of the shareholder.

The first of these cases is the “Family Company,” the חברה משפחתית.

There were fairly significant changes to these rules that came into effect as of 1st August 2013, and what follows are the new rules which apply to companies setting up after that date.

A company can only be considered a Family Company if:

(a) all of the shareholders are considered part of the same family for tax purposes. Essentially, this means (grand)parents, (grand)children, siblings and the spouses of the above.

(b) the election to be considered a Family Company has to be made within 3 months of the incorporation of the Company.

Under the tax regulations, the income of such a company is attributed to one (and only one) of the shareholders, and included on their tax return. By default, this is the largest shareholder, but any shareholder may be chosen for this purposes. This shareholder is known as the “representative”.

The business income of the Company is treated as unearned income in the hands of the representative, and taxed accordingly (starting at 31%). Other, passive income, is treated in the same way as if the assets were held by the shareholder directly. For example, if the income of the Company is from interest, the income would be taxed at 25%. If there is a loss in the company, the representative can use them in the same way as if they’d been his/her own personal losses (see here for more)

For Bituach Leumi purposes, the income is divided between the shareholders in accordance with their percentage holdings, and taxed as unearned income accordingly.

The upshot of this is that when monies are distributed by the company, there is no tax on the “dividend” paid. The (potential) downside is that the company cannot defer taxes by not distributing profits, as a regular company may choose to do.

There are of course further nuances to this law, and expert advice should be sought if you are thinking of going down this route. It should be noted that it is fairly simple to cease the company being treated as a Family Company. However, be aware that once the company becomes a regular company, it cannot become a Family Company again.