November 18 2011
Service companies are a common feature of the Israeli fiscal landscape. They
serve two main purposes. First, they allow their ultimate owners (ie,
shareholders) to draw dividends in lieu of salaries. Dividends are not subject
to the substantial national insurance contributions. Usually, the shareholder
receives a salary from the company, computed in such a manner as to gain the
maximum benefit from the personal credits and progressive rates of the tax
system. Since the total company tax and dividend tax is a flat 43% (of which
24% is company tax and 25% is dividend tax on the profit after company tax),
the salary takes advantage of progressive rates up to that threshold. The
taxpayer even benefits from the flat tax as it is lower than the 45% maximum
rate prescribed by the Income Tax Ordinance for ordinary income.
The second purpose of
service companies is the accumulation of profits subject merely to the company
tax, charged at 24%. Thus, the dividend tax may be deferred while the company
invests its retained earnings in income-producing investments.
On October 27 2011
judgment was delivered in theYamincase, in which a taxpayer
set up a company and claimed that it was the recipient of certain 'management
fees' paid by another company. The assessing officer argued that the sums paid
were paid to the taxpayer and therefore assessed him for tax on them.
When assessing whose
income it was, the court agreed with the taxpayer that he had a right to
incorporate and to have his business conducted by a corporation, which enjoyed
a legal personality of its own. However, the court found that the taxpayer, not
his company, was the party entitled to the amounts paid by the other company.
The company had nothing to do with the payer while the taxpayer was, for all
purposes, its employee. The payments were therefore classed as employment
The court pointed out
that the taxpayer served as the chairman of the board of directors and chief
financial officer of the payer - these are personal services, which a company
cannot perform. This holding has led some to believe that the demise of the
service company is near. However, this is not so. A service company may provide
services for a fee and be remunerated for such services. InYaminthe
company never billed for services and never paid its shareholder (the taxpayer)
for the services he rendered. It is therefore little wonder that the court
refused to regard the company as having been even minimally involved in
deriving the income.