Excess profitability — section 62A(a1)

From tax year 2025, a company whose main activity is based on the personal exertion of its shareholders (for example, professional services), and whose profitability from that activity is high, may have to attribute part of the profit to the active shareholders as if they had earned it directly.

The main tests

• The profitability rate of the personal-exertion activity exceeds 25%.
• Turnover does not exceed ILS 30,000,000 per controlling shareholder (a controlling shareholder and a relative count as one).
• The company's accumulated profits and the existence of other companies in the group are also examined.

Computing the profitability rate

The taxable income from the activity — profit before tax, less other income (such as financing and rent), plus non-deductible expenses and payments to a related company — is divided by the turnover of that activity. "Other income" — interest, dividends, rent and proceeds from the sale of assets — is not included in turnover.

Example

The company's turnover from a personal-exertion activity in the tax year is ILS 2,000,000, and the taxable income from it (after the adjustments above) is ILS 800,000. The profitability rate — 800,000 ÷ 2,000,000 = 40%, which exceeds 25%. Therefore, subject to the other conditions of the section, the company is within section 62A(a1), and the attribution to the active shareholders must be examined.

Attribution to the shareholders

The profit is attributed only to the active shareholders — those engaged in the activity. A shareholder who is not active receives no attribution. A dividend distributed to the active shareholders during the year is taken into account.

Transition rule for tax year 2025

For tax year 2025 only, the profitability rate may be computed as an average of 2023–2025. This requires the figures for 2023 and 2024.

Tax estimate during the year

Since the attribution affects the shareholders' advance payments, it is recommended to estimate the profitability rate during the tax year, based on a profit and loss statement for the period, and to extrapolate the figures to a full year.

Another example — low profitability

The company's turnover from a personal-exertion activity is ILS 3,000,000 and the taxable income from it is ILS 600,000. The profitability rate — 600,000 ÷ 3,000,000 = 20%, which does not exceed 25%. Therefore there is no attribution under section 62A(a1) for this activity.

Splitting between activities

A company may at the same time engage in a personal-exertion activity, an activity under section 62A(a) and other income. The profitability test applies to the personal-exertion activity only, so its income and expenses must be separated. Shared expenses are allocated on a reasonable basis, such as the ratio of income.

Recommended work order

• Review the scope conditions — turnover, accumulated profits and other companies in the group.
• Separate the personal-exertion activity from the other activities.
• Compute the taxable income from the activity after the required adjustments.
• Compute the profitability rate and compare it with 25%.
• Identify the active shareholders and compute the attribution, taking into account the dividend distributed to them.
• Update the shareholders' advance payments accordingly.

Frequently asked questions

Who is an "active shareholder"? A shareholder engaged in the company's activity. It is recommended to mark this in the client card so that the attribution is computed for that shareholder only.

Can the attribution be reduced through salary? A salary to the shareholder is a company expense and reduces the profitability rate; the overall effect on the tax burden should be examined.

Notes

• The section and the Tax Authority guidance include further exceptions and conditions not detailed in this article.
• Each case must be reviewed on its own merits.