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New ITA circular, Aug 2015



On August 16, 2015, the Israel Tax Authority published a new circular (number 8/2015), which is effective immediately. The circular presents the new material requisite tests and criteria for recognizing an organization as a ‘public institution’ pursuant to section 46 of the Israeli Income Tax Ordinance. Certification issued to an organization pursuant to section 46 of the Income Tax Ordinance confers a tax benefit, by way of tax credits to donors in respect of donations they grant to that organization, at a rate of 35% for an individual donor and 26.5% for a corporate donor (according to the corporate tax rate).


The new circular, which supersedes the previous circular in this regard from 2001, is the outcome of conclusions drawn by a public committee headed by retired judge, Sarah Frisch, in May 2014.The committee had been formed at the instruction of the Supreme Court in the Vipassana case in August 2012 (HCJ 10893/08), which ordered that a clear policy must be set regarding the certification proceedings pursuant to section 46.


The Israel Tax Authority is expected to publish an additional circular to support circular 8/2015, which will address the technical/procedural aspects of ascertaining eligibility for certification pursuant to section 46 of the Israeli Income Tax Ordinance. It should be noted in this regard that a portion of those technical/procedural aspects included among the Frisch Committee’s recommendations are already being applied in practice on an ad-hoc basis, within the scope of a procedure that was adopted a few months ago by the Finance Committee (during the term of the 19th Knesset) in collaboration with the ITA. The Frisch Committee recommendations also include amendments to current legislation (such as expanding the public objects specified in section 9 (2) of the Income Tax Ordinance), which will likely be enacted in the near future, along with additional developments in this regard.


The following is a review of the highlights of the material changes included in the ITA’s new circular. The circular creates clarity and hones the material rules and criteria used by the ITA when considering whether to recognize an organization as a public institution for the purposes of section 46 of the Income Tax Ordinance. When perusing the new circular, one also clearly sees a trend towards imposing more stringent rules on third-sector organizations with regard to supervision, control and transparency. This trend has also received expression recently in legislation, rules and directives issued by additional regulatory authorities, such as the Corporations Authority of the Ministry of Justice, which are updated periodically.


Investment channels


The new circular clarifies the general provision included in the previous circular on the subject of institutions’ investments. The new circular defines a list of solid investment channels for institutions’ undesignated funds and refers in this regard to the Companies Law (Amendment no. 23), 5774 – 2013 (and according to the rules prescribed in the Third Addendum to the Companies Law, which are included in the said amendment) – which addresses the topic of solid investment channels for surplus cash in ‘Public Benefit Foundations’ (a new type of NPO that was recently recognized in legislation). Additional solid investment channels that have been approved by a designated supervisory authority for the field relevant to the institution (such as: institutes of higher education that invest with the approval of the Budget and Planning Committee) will also be recognized.


The circular further states that institutions’ investment channels must be examined by an accountant and his opinion in this regard must be submitted to the ITA.


Assets accumulation


The ITA is adopting the provisions regarding assets accumulation prescribed by the MOJ’s Corporations Authority in its Rules of Proper Management (relating to NPOs and public benefit companies) and, for the first time, the ITA will be examining the method by which institutions are accumulating assets. The new circular declares a ban on any unreasonable accumulation of surpluses, based on the principle that the raison d’être of such public institutions is to work towards promoting their objects and not to accumulate surplus cash, and based on the fundamental assumption that donors expect their donations to be used to directly promote the institution’s objects within a reasonable time frame.

The circular also advises that institutions will be allowed to accumulate a reasonable sum for their operating activities, including for the purpose of contending with crises and difficulties. However, the circular clarifies that the accumulation of surpluses at a ratio exceeding 100% of the institution’s operating turnover will only be allowed when circumstances justify doing so and are backed by data and supporting documents (such as the donor’s consent). In any event, every institution must present a credible, intelligent plan for utilizing the accumulated funds in the foreseeable future, including a detailed three-year plan of the institution’s activities.


It should be noted in this context that the annual turnover test, as adopted in the new circular, is inconsistent with the recent amendment included in the Registrar of NPO’s new directives of February 2015 (“Rules of Proper Management”), which announced an amendment to the Registrar of NPO’s policy as it concerns surpluses, whereby NPOs shall be required to provide an explanation justifying the existence of surpluses in the NPO, only if the accumulated surpluses are at a ratio exceeding 200% of the turnover for three consecutive years (and not as stated in the ITA’s new circular, which refers to surpluses in excess of 100% of the turnover, and does not refer to the time frame during which such surpluses were accumulated).


Furthermore, that same new rule of thumb currently being adopted by the ITA (in the wake of the Corporations Authority directives), that allows assets to be accumulated up to 100% or 200% of an organization’s annual turnover is not free of criticism, and this criticism has been steadily growing of late. Critics are maintaining that the creation of such an arbitrary technical rule of thumb is actually counterproductive and constitutes an undesirable policy. Critics argue that such policy is actually liable to cause organizations damage and might constitute excessive direct intervention by the regulatory authorities in the management of organizations’ internal affairs. Actually, such a policy is liable to adversely affect organizations’ financial stability, to constrain their efforts to build long-range action plans and fails to take into account major one-time donations that such organizations often receive through estates, wills, bequests, etc. Moreover, this criterion is liable to induce organizations to squander funds towards the end of the accounting year in order to not be caught with surplus assets, which could trigger superfluous audit and control actions by the regulatory authorities.


Salary limits


For the first time, a maximum permitted salary has been set for managers and employees of public institutions. The circular prescribes that the salaries of managers and employees of public institutions may not exceed the maximum wage cost of a director-general of a government ministry, according to the wage tables defined for the public sector, except for organizations bound by sectoral or collective wage agreements. The ITA is expected to publish detailed directives in this regard in a later circular.


The issue of executive salaries in third-sector organizations has been the subject of public criticism lately, but it appears that such criticism is not really justified. Empirical data on this sector (taken from the annual report of NPOs in Israel prepared by GuideStar Israel) show that the salaries being paid in this sector are fair and reasonable, with the average monthly salary of the five employees receiving the highest salaries in this sector being about NIS 8,000, while the average monthly salary of the most senior employee (usually the CEO) in this sector is about NIS 11,000 – after neutralizing the data on those executives who are receiving salaries far exceeding the average (which, for the most part, are paid by major economic bodies, such as philanthropic funds, international organizations, major health institutions, etc.).


It should be noted that the directives of the Office of the Accountant-General already define a ceiling for administrative and general expenses (including wages of managers and employees) in organizations receiving government ministry support directly from the State budget, as well as in organizations that are indirectly supported by the State, due to their status as recognized public institutions, pursuant to section 46 of the Income Tax Ordinance. As a precondition for such support and/or recognition, these rules define the permitted ratio of administrative and general expenses out of the organization’s total financial turnover and define those components that must be included under administrative and general expenses. We will have to wait until the ITA releases its supplementary circular in order to examine and understand whether the wage restriction is in keeping with the Accountant-General’s current directives.


Business activity (“social businesses”)


The circular prescribes, for the first time, that an institution may also conduct business activity that is separate and distinct from its public activity, under the following cumulative conditions: (a) the volume of business activity is immaterial relative to the institution’s total activity, the business activity is unrelated to the core public activity (such as employment of handicapped persons), and the business activity does not constitute more than 25% of the institution’s activities); and (b) the institution manages two separate sets of books, one for its public activities and the other for its business activities, and it duly reports on its business revenues.


This directive was incorporated in the new circular, at the recommendation of the Frisch Committee, inter alia, in order to provide a solution (even if only partially) for the evolution of “social businesses” in the Israeli economy in recent years (“the fourth sector”). Also in this instance, we can expect the enactment of a series of regulations relating to the tax issues for these businesses, but not in the near future.


Activities abroad


The circular prescribes, for the first time, that institutions operating abroad for the benefit of Israeli citizens abroad can also benefit from the tax benefit. Institutions whose activities are clearly in the national interest (such as public relations) or that constitute urgent and immediate humanitarian activities (such as providing aid during disasters and crises occurring around the world) will also be approved, subject to approval from the Ministry of Finance and the Ministry of Foreign Affairs. Approvals for such institutions may be for a defined period, depending upon the nature of the activity.


And what did not change?


Alongside the innovations in the new circular highlighted above, a number of criteria were not amended. One criterion left unchanged – notwithstanding the public outcry – is the criterion that states that an organization that directly or indirectly assists political-partisan activity shall be disqualified for recognition as a public institution for the purposes of section 46 of the Income Tax Ordinance.

This criterion has been left as vague as before. Based on past experience, its current wording is liable to cause many civil society organizations, whose activities might also contain a “political” element, aimed at encouraging civil activism, promoting public debate or influencing decision-makers on topics on the public agenda (also through criticism), to not receive the yearning recognition for tax purposes and thus reduce or even prevent them from raising funds from the public for such activities they promote and thwart their activities.

It would have been advisable and appropriate to take advantage of this opportunity and amend this criterion as well. Developed and democratic countries differentiate between civil activities and political activities: between lawful civil-social activities that take an opposing stance to that of the decision-makers and the government regime or that are geared towards influencing them (with the umbrella organization qualifying for tax benefits when raising funds for such activities) – and political activities that are essentially geared towards supporting a political party or candidate (which are not entitled to tax benefits when raising funds). A good example of this is the federal law known as ‘McCain–Feingold Act’ (the Bipartisan Campaign Reform Act), which was legislated in the United States in 2002. This federal law draws a clear line between activities promoting objectives of political parties and activities that are partisan or a-political in nature.


In this context, the Frisch Committee expounded on the importance of civil society in the report of its recommendations, and emphasized that civil society is a foundation stone of every country, which serves to strengthen democracy and national social resilience. Civil society organizations manifest active and involved citizenship, serve as “watchdogs” for democracy and help to maintain equilibrium between the government, the economy and society. Many such organizations focus on protecting civil rights, issue alerts about social wrongs, place issues on the public agenda and criticize public policies and modes of policy implementation. There is a need to empower civil society organizations, both as providers of social services that the State is unable to provide, and as providers of an arena where citizens can assemble, speak their minds and influence the public agenda.


This need, as stressed in the Frisch Committee’s report, is particularly critical, in light of the structure of Israeli society, which is replete with social rifts and tension (between the secular and the ultra-religious, between worldviews in the spectrum of left-wingers and right-wingers, between Sephardi and Ashkenazi ethnic groups and tensions caused by socio-economic gaps). All of these social rifts need a pluralistic and fair arena that recognizes social, ethnic and cultural diversity, promotes the easing of tensions, narrows rifts and encourages diverse groups to express themselves, promote their various agenda, learn to accept diversity and foster fruitful dialogue.


If civil society organizations are not recognized as public institutions for tax purposes as a result of legally promoting a particular activity and they are unable to raise donations from the general public, the impact on civil society might be devastating.



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