The Obligation to Withhold Tax at Source from Income, the Payment Date of Which Precedes the Date of the Tax Event

Newsletter 03/2021

The Obligation to Withhold Tax at Source from Income, the Payment Date of Which Precedes the Date of the Tax Event

Sections 164 and 173 of the Income Tax Ordinance set forth a series of provisions regarding the obligation to withhold tax at source. According to these provisions, a “payer” of income must withhold tax at source from payments made to the income’s “recipient” and must transfer the amount withheld directly to the Tax Authority, provided the recipient does not have an exemption from withholding tax at source with respect to that income. The withholding tax obligation is founded upon two pillars: first – the presence of actual payment (in cash or cash equivalent), and second – the presence of a provision that sets forth the manner and rate at which tax must be withheld at source.

Under various provisions in the Ordinance, there are cases in which, at the date of payment no income is accrued for the recipient, and the tax event is not generated until later, when certain conditions are met. Examples of this type of case are: income from debt forgiveness, income from an imputed dividend from loans granted to a material shareholder (Section 3 (i1) of the Ordinance), income from imputed interest on a loan for the benefit of a controlling shareholder in a company (Section 3(i) of the Ordinance), and more. In our opinion, in some cases of this type, the conditions required for withholding tax at source are not met:

1. The presence of actual payment – Since on the date when the income was accrued in these cases, no actual payment was made, in cash or cash equivalent, there is no payment from which the payer can withhold tax. In our opinion, no liability to withhold tax at source can occur retroactively just because there is a potential tax event at a future date with respect to payments executed in the past.

2. The presence of a provision that sets forth the manner and rate at which tax must be withheld at source – Under Section 164 of the Ordinance, numerous orders have been issued prescribing that various payments should be considered as “income” for the purposes of the section on withholding tax at source, and accordingly numerous regulations were also enacted prescribing the rules for the manner of withholding tax at source. However, these orders and regulations do not have provisions that apply an obligation to withhold tax at source to imputed income in cases of the kind detailed in the above examples. It should be noted that there are specific cases in which the Legislator prescribed that even certain types of imputed income are subject to withholding tax at source, a fact which reinforces our position that in the remaining cases, where no provision was prescribed as above, no obligation to withhold tax at source applies.

In light of the above, we believe there is no obligation to withhold tax at source with respect to some of the types of imputed income described above. Due to the issue’s complexity, each case must be considered individually, and legal counsel should be sought before making decisions on the matter.

For additional information, contact Adv. (CPA) Shahar Strauss or CPA Nofar Zigdon from our firm.