Key points
- A distribution is permitted only out of profits, and only if there is no reasonable concern that it will prevent the company from meeting its obligations (section 302 of the Companies Law).
- On distribution, tax is withheld at 25%, or 30% for a substantial shareholder.
- A distribution in the following year may also serve to apply section 81 to the excess profits.
A dividend is the main way a company passes its accumulated profits to its shareholders. Alongside the tax rules, a distribution is subject to the limits of the Companies Law, which are designed to protect the company's creditors.
The distribution tests — section 302 of the Companies Law
- The profit test: the distribution is made out of "profits" — retained earnings, or the retained earnings accumulated in the last two years, whichever is higher.
- The solvency test: there is no reasonable concern that the distribution will prevent the company from meeting its existing and expected obligations when they fall due.
- A distribution that does not meet the profit test requires court approval (section 303 of the Companies Law).
The distribution decision
As a rule, the decision to distribute a dividend is made by the company's board of directors (section 307 of the Companies Law), unless the articles provide otherwise. It is recommended to document in the minutes the review of both tests, the amount of the distribution and the payment date.
Withholding at source
When paying a dividend to an individual shareholder, the company withholds tax at 25%, or 30% for a substantial shareholder (holding 10% or more). The surtax is not withheld and is paid with the annual return.
Example
A company has retained earnings of ILS 2,000,000, and the board reviewed and found no concern for its solvency. It was decided to distribute a dividend of ILS 400,000 to an individual shareholder holding 100% of the shares.
- The profit test: 400,000 ≤ 2,000,000 — met.
- Withholding at source: 400,000 × 30% = ILS 120,000.
- Net amount on the payment date: 400,000 − 120,000 = ILS 280,000.
The link to section 81 — undistributed profits
In a company to which sections 81A–81F apply, a dividend distributed by the end of the year following the tax year (or by the filing date, if earlier) may serve to apply the section to the excess profits, instead of paying the "additional tax". The amount of the distribution should therefore also be reviewed against the distribution requirement under section 81.
Recommended work order
- Review the retained earnings according to the financial statements or the trial balance.
- Review solvency — cash flow, liabilities and expected liabilities.
- Review the distribution requirement under section 81 and the effect of the distribution on section 62A.
- Make a board decision and document it.
- Withhold the tax at source, remit it and report as required.
Frequently asked questions
Can a dividend be distributed by a company with losses in the current year? Possibly — the profit test looks at retained earnings or the retained earnings of the last two years, not only at the current year's profit. The solvency test must also be reviewed.
Does the shareholder receive the gross dividend? No — the company withholds the dividend tax and transfers the net amount to the shareholder.
Notes
- This does not replace legal advice on compliance with the Companies Law.
- Different withholding rates may apply to a non-resident shareholder under a double taxation treaty.
Sources
- Companies Law, 1999, sections 302 and 307
- Income Tax Ordinance, sections 125B and 81A–81F
Rates and amounts are correct as of the update date. This is a translation of the Hebrew article; in case of a discrepancy, the Hebrew version prevails.
This article is for general information only. It does not constitute tax advice or a professional opinion, and does not replace a specific review of each case.