Quietly and without much media attention in the financial press, one of the most dramatic reforms in recent years has come into effect in the Israeli tax system – the Locked Profits Law.
Owners of closely held companies (companies with up to 5 shareholders), who until now were accustomed to retaining profits within the company without incurring additional tax, are now facing a new reality: either distribute the profits and pay the applicable tax, or pay an annual penalty of 2% on undistributed profits. Additionally – a special benefit applies only in 2025.
What Exactly Are “Locked Profits”?
Locked profits refer to amounts accumulated within a company after paying the standard corporate tax rate (23%) but not distributed as dividends.
For example: if a company has accumulated profits of ₪3 million over the years and has not distributed them, these are considered locked profits.
Until 2024, this wasn’t an issue. However, starting January 2025, a significant change has taken place. In light of the war with Iran (Operation Am KeLavi) and the ongoing crisis since October 7th, the Israeli government must reduce a substantial budget deficit. Taxing locked profits is one of the most prominent solutions.
Locked Profits Taxation: How Does It Work?
According to Amendment 277 to the Income Tax Ordinance, any company defined as a “closely held company” (up to 5 controlling shareholders) will be required each year to choose between two options:
- Pay a 2% annual tax on “excess retained earnings” – i.e., undistributed profits after deducting tax shields
- Distribute dividends equal to at least 6% of accumulated profits (only 5% in 2025)
The implication: any company that takes no action will still be taxed – even without distributing a single shekel.
So What’s Better: Pay the Penalty or Distribute Profits?
There’s no one-size-fits-all answer. Each case must be assessed individually based on the company’s profit structure, cash flow, investment plans, and even the personal tax considerations of its shareholders.
However, it’s important to understand: distributing dividends reduces the tax base for future years. In other words, a well-planned distribution today can save significant tax in the years ahead.
What Is the One-Time Opportunity in 2025?
A dividend distribution of just 5% is enough to qualify for an exemption from the annual 2% tax.
A temporary order allows for the liquidation of closely held companies – including exemptions from purchase tax and VAT on asset transfers from the company to the shareholder – until 31 December 2025.
Additionally, under the same temporary order, assets can be transferred from the company to the shareholder at their original cost as a dividend, avoiding both the penalty and the 5% distribution requirement. This transfer must be completed by 30 November 2025.
Why Is It Important to Act Now?
Company owners who delay their decision may find themselves exposed to unnecessary tax by year-end.
Moreover, the new law applies retroactively to all profits accumulated from the company’s inception up to 31 December 2024 – including capital gains, real estate appreciation, and other exempt income. These represent billions of shekels across the Israeli economy, clearly targeted by the Tax Authority.
Want to Understand How the Law Affects Your Company?
At Shtainmetz Aminoach & Co. CPAs, we specialize in tax planning and advising closely held companies. We assist thousands of clients in assessing their exposure, calculating locked profits, and determining the optimal tax strategy – including dividend splitting, selecting exemption routes, or initiating a company liquidation. All with one goal: achieving the most favourable tax outcome for our clients.
Contact us today to assess your company’s exposure and build a smart, tailored tax strategy before the 2025 deadline.
Click here to leave your details for a callback or dial 077-7700000.
