What is a family company? When is it beneficial to use a family company?

There is a special taxation system in Israel to companies comprising of shareholders who are first degree relatives.

A “family company” is defined as follows: a company that consists of any of the following family members: spouse, brother, sister, parent, parents of a parent, offspring and offspring’s spouse, and the spouse of any of the above.

The principal meaning of a “family” company concerns its classification by the tax authorities as a separate legal entity. However, its gains or losses are considered as the gain or loss of the company’s controlling shareholder who is considered as the “representative assessee.”

The family company will start being considered as a family company following its request, furnished to the Assessing Officer no later than one month before the start of the tax year, and in the event the company was incorporated lately it has to submit an application to be considered a family company three months following its incorporation. The consent of the party with the highest share in the company’s earnings should be enclosed to the application to serve as “representative assessee” as said.

The “representative assessee” also known as “assessed member” represents the company and is taxed on the company’s income before the tax authorities.

The tax on the company’s income will be calculated according to tax rates imposed on the principal shareholder as a “single” and not company shareholder, and this also allows offsetting individual losses of the “representative assessee” even though this is a company.

Except for taxation, a family company is a limited liability company and a legal entity that can institute legal action and be the subject of legal action.

Different than a regular company that is not taxed on a dividend received from subsidiaries, a family company will pay tax on a dividend as if the dividend was received by a private person.

If a shareholder in a family company sells part of his shares to a person who is not defined as a “relative,” the company’s status as a family company will expire as of the beginning of the tax year.

 

Tax planning with a family company

The family company is entitled to decide, until the date of submission of the annual reports in respect of a certain tax year, that it ceases to function as a family company starting from that tax year, and in such event “a company that ceased to be an entitled family company cannot request to become an entitled company before termination of three tax years from the year it ceased to be entitled.”

You should carefully consider whether it is worthwhile that your company will be considered a family company in accordance with the income tax laws since a family company also has disadvantages in the area of taxation. For example, if the family company is interested in investing in equipment or assets, it cannot use undivided profits for the purpose of investing in equipment or assets and later on it will pay full marginal tax as applicable to the representative assessee, that is to say the assessee will pay 48% tax if a high marginal tax applies to the assessee, and not 29% companies tax as applicable to companies.

 

The future concept: “transparent company”

In fact, Section 64A is expected to be repealed when the regulations by virtue of Section 64A1 concerning a transparent company will come into force. Section 64A1, referring to a transparent company,  is already included in the Income Tax Ordinance however its application is delayed due to failure to enact regulations on the matter by the Minister of Finance.

A transparent company is an arrangement that exists in many western countries including the U.S.A. and is meant to replace the family company status.

 

* Eti Sadis Law Firm was established in 1997. Adv. Eti Sadis has many years of experience in conducting complex and sensitive inheritance disputes and provides nationwide representation to inheritors and estates, representation before the Inheritance Registrar and in family courts throughout the country – including estates in Tel Aviv, Ramat Gan, Kfar Shmaryahu, Zichron Yaakov, Binyamina, Karkur, Hadera, Caesarea, Or Akiva, Netanya, Kfar Yona, Herzliya, Ra’anana, Kfar Saba, Hod HaSharon, Petah Tikva and Rosh HaAyin.

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