Israel’s new deemed distribution rules – a trap for the unwary multinational taxpayer

by Yuval Navot and Ronen Avner — Herzog Fox & Neeman, Tel Aviv

The Israeli Tax Authority on August 23 published a circular which interprets Israel’s newly enacted deemed distribution rules in a draconian manner. The new legislation along with the circular requires proper attention by multinational taxpayers with Israeli subsidiaries that extend intercompany loans or guarantees.

New Israeli Income Tax Ordinance section 3(i1), enacted on December 29, 2016, and effective January 1, provides that a loan from an Israeli company to its 10 percent or more shareholders or to their related parties, outstanding for a given period of time, is deemed to have been distributed to these shareholders.

How much time must a loan be outstanding in order to trigger the deemed distribution rule? Well, not much.

The deemed distribution takes place at the end of the year following the year in which the loan was extended. So, for example, a loan extended October 2017 and not repaid until December 31, 2018, will be deemed to have been distributed on December 31, 2018.

The distribution is characterized as a dividend to the extent the company has distributable earnings as determined under Israeli corporate law or as business income to the extent that the company has no such distributable earnings.

The new section contains an anti-abuse rule targeted to avoid repayment of loans and subsequent withdrawals around the deemed distribution date.

The new section also contains an important exception to this deemed distribution regime where the loan is between companies and is used to serve a business purpose of the corporate borrower.

A temporary provision provides another exception with respect to loans that were repaid to the corporate lender on or before December 31, 2017. Such loans are outside the scope of the new section (although a deemed distribution under general tax principles can still apply to loans extended before January 1, 2013).

The new circular

The circular is intended to reflect the Israeli tax authority’s views and guidance to tax inspectors. It is important to note that the circular is not legally binding on taxpayers or courts. The circular is draconic in a number of aspects.

The legislation was originally targeted to individual controlling shareholders, not companies and our (perhaps naive) hope was that the circular would clarify that this is in fact the way the tax authority sees the legislation. Well, that is not the case. The circular only notes that the legislation will not apply to shareholders that are Israeli companies. Non-Israeli corporate shareholders are still in.

Business purpose exception

Further, the exception from the deemed distribution rules available for business purpose loans is narrowly interpreted in the circular to apply only to loans to affiliates, as opposed to loans to direct shareholders.

No policy consideration supporting this position is provided in the circular. Therefore, careful consideration must be given to subsidiary-to-parent loans and to the proper way of structuring loans from Israeli companies.

The circular also requires that any such loan that purports to satisfy this exception must be evidenced by a loan document.  Inter-company balances would not qualify.


There is also nothing in the circular stating that a customary subsidiary guarantee of parent’s or affiliates’ liabilities, used in standard group financing arrangements should be excluded from the legislation.

Such an exception would have been very important, as guarantees are viewed, under the new rules, as actual loans. As noted, the business purpose exception is not applicable to loans to an immediate parent.

The new deemed dividend rule may result in conflicting characterizations of a loan from an Israeli subsidiary to a non-Israeli shareholder or affiliate. Israel may view the loan as giving rise to a deemed dividend, while the residence state of the corporate shareholder or affiliate may very likely view the loan simply as a loan.

Such mismatches are, of course, a good recipe to tax traps, particularly around availability of foreign tax credits.

Proper structuring

The new provisions give further emphasis to the importance of proper tax structuring of inter-company lending arrangements, guarantees, and investments. Debt financing may serve a better result if a repatriation policy is sought.

It is worth considering certain hybrid instruments offered by Israel tax rules allowing for such repatriation with no withholding tax. Redeemable shares are also a good option.

— Yuval Navot is a partner with Herzog, Fox & Neeman, Tel Aviv (

Ronen Avner is an associate at Herzog Fox & Neeman, Tel Aviv (




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