Legal Updates

Funds withdrawn from a company by a shareholder and not repaid may be deemed taxable dividend income

June 17, 2020

An owner of a company withdrew funds accumulated in the amount of ILS 2,200,000 without reporting it to the Tax Authorities and without paying tax, contending that it was a loan intended to be repaid to the company.
The Court held that the funds are classified as a taxable dividend because such were not repaid, and the shareholder did not show any intention of repaying them. Each transaction must be reviewed pursuant to its true economic nature and under the circumstances, and not according to the formal appearance or name given to it by the parties. In order to determine whether a withdrawal from a company is a dividend or a loan, one should review its terms and conditions, as well as its characteristics. This classification is essential, because if the withdrawal is classified as a loan, it is to be repaid and will not be taxable. On the other hand, a dividend would not be repaid but would be taxed. Such classification is of great importance for the prevention of exploitation by controlling shareholders, especially in non-public companies, which are subject to lighter reporting obligations. Even withdrawal of funds from a company by its controlling shareholder, without being charged interest, will be deemed dividend income. Here, the shareholder did not anchor the loan in an agreement, the loan was not recorded in the company books, no explicit commitment was made to repay the funds and de facto no funds were repaid. Thus, the withdrawal of the funds should be classified as a dividend and taxable as such.