Taxing of Wallet Companies

Taxing of Wallet Companies

January 18, 2017

Many high-wage employees use 'Wallet Companies' in order to try and reduce their tax burden. The 2017 tax reform may put many of them at risk of high rate taxation.

Every year the Tax Authority is pushing to close, or at least reduce, the gaps in Israeli tax net. A faulty taxation planning of transaction may lead to “tax accidents” under which the transaction is not subject to the tax contemplated. As part of significant reforms pushed by the Tax Authority, as of January, 2017, a new tax regime empowers the Israeli Tax Authority to tax income of those who employ wallet companies and see the income of the company as salary of their shareholder.

Wallet companies are a common tax planning tool among high-wage employees. In that manner, instead of receiving a salary as an employee and immediately being taxed, a company is established the sole purpose of which is to receive the payment for the "services" of the “employee” to the employer. The “employee” becomes an employee of the employee’s wallet company (or otherwise withdrawing profits from it), the wallet company deducts expenses (that otherwise an employee may not deduct as expenses) and the employee may withdraw only part of the salary and pay the full tax only on that specific part, which is likely to also be at a reduced rate than the regular income tax.

The new amendment creates mechanisms to allows a more “efficient” taxation of the income of persons acting through wallet companies and now this income will be treated as a regular salary of the shareholder. Thus, the income of a wallet company which main activity derives from a major shareholder and a single  major source of income, will be deemed salary of the major shareholder, and this in several situations, especially a situation where the activity from which the income derives is the kind of activity carried out by an employee for an employer.  Moreover, the amendment stipulates that a self employed, 70% of whose income is from a single source for a period of at least 30 consecutive months, will be taxed as an employee and there will not be any advantage to work in the structure of  a wallet company. In addition, the amendment sets that  accumulated earnings of ILS 5 Million that was not distributed by a company for 5 years will be taxed as if distributed.

As any net deployed, the tax net may sometimes also catch "fishes" which not intended for. Whether it is the drafting of a high-salary employment contract or the structuring of a merger and acquisition or other complex transactions, the correct transaction structuring is today even more important than ever in order to avoid a situation where the structure is caught by the new “tax net” intended for wallet companies. Thus, it is recommended to consult with a lawyer who is also familiar with such updates in order to avoid any tax accidents resulting from the use of obsolete structures.