What was added to the Ordinance

The Economic Efficiency Law (Legislative Amendments for Achieving the Budget Targets for 2025) of 2024 added a new sub-chapter containing sections 81A to 81F, in force from 1 January 2025 and applying to profits accumulated up to that date as well. The purpose of the regime, as the Tax Authority circulars and the case law present it, is to limit prolonged deferral of the dividend stage of taxation where the profits are not used in the business. The regime applies to a closely held company as defined in section 76(a) of the Ordinance.

Three steps to the charge base

The charge base is not the whole of the accumulated profits. The accumulated profits are determined first; from them the taxable accumulated profits are derived, after neutralising exempt accumulated profits; and under section 81C the excess profits are computed as the difference between the taxable accumulated profits at the end of the preceding tax year and the highest of three amounts. Section 81B(a) imposes the charge itself: a surcharge of 2 per cent of the excess profits as computed under section 81C, after deducting a dividend distributed during the tax year.

The three amounts are not cumulative, and only the highest is taken. Section 81C does not exempt every productive investment. It defines special assets and excludes categories of assets from the computation, so a substantial holding of assets that are not classified as special assets, or to which the exclusions in the section apply, may raise the asset shield and bring the excess profits to zero.

The three alternatives in section 81B(b)

The surcharge does not apply to a company in which one of the following occurred: the company losses for the tax year exceed 10 per cent of the accumulated profits at the end of the preceding tax year; the amount of dividends on which tax was paid on distribution exceeds 50 per cent of the excess profits at the end of the preceding tax year, so a distribution of exactly 50 per cent is not enough; or the amount of dividends on which tax was paid on distribution is 6 per cent or more of the accumulated profits at the end of the preceding tax year.

Two points of precision. First, distribution alone is not enough. What counts is a dividend on which tax was paid on its distribution, and in certain circumstances an inter-company dividend for which the payment route laid down in the Income Tax Regulations (Dividends on which Tax was Paid on Distribution) of 2025 was elected. Second, there is a gap in the wording: section 81B(b)(2) reads “exceeds 50%”, while Income Tax Circular 2/2026 of 25 January 2026 words it as “at least 50%”. Until this is clarified, the statutory wording governs. How an inter-company dividend is distributed, the two routes in the regulations and the position of an intermediate company are set out in a separate article.

Reporting and payment dates

The company reports the surcharge in its annual return. Payment is made by the earlier of the filing date of the return for the tax year under examination and the end of the following tax year, and the same applies to the reporting and payment dates for the dividend alternatives in section 81B(b)(2) and (3). A surcharge not paid by that date carries linkage differentials and interest. For tax year 2025, 31 December 2026 is the latest possible date, and where the return is filed earlier, the filing date governs.

The transitional provision for 2025

For tax year 2025 a transitional provision was enacted under which a dividend of 5 per cent or more of the accumulated profits at the end of the preceding tax year may prevent the charge, subject to payment of the tax on the distribution by 31 December 2025. The provision tied the determining period for receipt of the dividend to 30 November 2025. Both dates have passed.

Circular 7/2025 and the February 2026 update

Income Tax Circular 7/2025 was published on 19 October 2025, and in February 2026 an update to it was published, Circular 7/25(1). The update changed the reporting and payment dates for the dividend alternatives and removed the reference to 30 April that appeared in the earlier text; deleted the provision on a dividend distributed in excess and the example relating to it; and corrected the example concerning land inventory and activity arising from income from a building. A review written today refers to the updated text.

What the High Court of Justice said

In HCJ 35810-08-25 and HCJ 6251-11-25, Association of Tax Representatives and others v. The Knesset and others, the Supreme Court described the core of the regime under sections 81B and 81C: a 2 per cent surcharge on excess profits, the excess profits being computed against the highest of the three amounts, and noted that a distribution of the size set out in section 81B(b), or losses at the required rate, may relieve the company of the surcharge. The petitions were heard as a constitutional matter, and sections 81B and 81C were not struck down.

Two changes made alongside it

Alongside the surcharge, the amounts in section 77 of the Ordinance, which empowers the Director to order a distribution of profits, were raised: the accumulated profits threshold from 5 million to 10 million shekels, and the amount that must remain in the company after the distribution from 3 million to 6 million shekels. Section 62A, which deals with wallet companies, was widened at the same time: the material shareholder test was replaced by a controlling shareholder test, the examination periods for the source of the income were shortened, and existing carve-outs for interests in a partnership were removed.

What is examined in each case

Whether the company meets the definition of a closely held company; whether exempt accumulated profits exist; whether there are rights in a transparent entity whose profits enter the accumulated profits; whether special assets exist; and whether the transitional provision applies. The rates of tax on the dividend itself and the application of the surtax are checked against the law in force for the relevant tax year.

Sources

Income Tax Ordinance, sections 81A to 81F, 76(a), 77 and 62A · Economic Efficiency Law (Legislative Amendments for Achieving the Budget Targets for 2025), 2024 · Income Tax Circular 7/2025, 19.10.2025, and its February 2026 update, Circular 7/25(1) · Income Tax Regulations (Dividends on which Tax was Paid on Distribution), 2025, published in Reshumot on 15.9.2025, and Income Tax Circular 2/2026 of 25.1.2026 · HCJ 35810-08-25 and HCJ 6251-11-25 Association of Tax Representatives and others v. The Knesset and others · CA 181/14 and CA 227/14 Pagi v. Assessing Officer Haifa · CA 8511/18 Assessing Officer Netanya v. Delek Hungary