A recent ruling by the Be'er Sheva District Court (Nuriel v. Eilat Assessing Officer) provided a significant tactical victory for taxpayers operating via service companies (often called "Wallet Companies"). The court ruled that a service provider who acts as a partner—even without a formal agreement—is protected from the aggressive "piercing of the corporate veil" by the Tax Authority.
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However, for foreign residents and international business owners operating in Israel, this ruling must be read with a major caveat. The legal defense used in this case has been abolished under the new tax reform (Amendment 277) effective January 1, 2025. What saved the taxpayer in the past will not save you today.
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Executive Summary

• The Ruling: The court recognized a de-facto partnership based on conduct (risk/reward sharing) rather than formal registration, shielding the taxpayer from high personal tax rates.
• The Shift: The "Partnership Exception," which protected partners from being classified as employees for tax purposes, was repealed in 2025.
• The New Reality: Starting 2025, the test shifts from Qualitative (Employee vs. Partner) to Quantitative (Profitability). Service companies with high profitability (>25%) will face automatic taxation on undistributed profits.
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The Case: Substance Over Form

The case concerned a CPA who provided services to a large accounting firm via his own private company. The Israel Tax Authority (ITA) argued that despite the corporate structure, the individual was essentially an employee of the large firm. Therefore, the ITA sought to apply Section 62A of the Ordinance ("Wallet Companies"), disregarding the company and taxing the individual at high marginal rates (up to 50%) plus social security.
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The taxpayer argued that he was not an employee, but a partner in the firm's Eilat branch, sharing risks and management duties.
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‍The Decision:
The court accepted the taxpayer's position. It ruled that the substance of the relationship—managerial control and financial risk—proved a partnership existed, even without a written contract. Since the law (at the time) contained a specific exception for partners, the ITA could not reclassify the income as salary.
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The Trap: Why This Ruling is "Dangerous" for 2025

While the ruling is favorable for open tax assessments from previous years, relying on it for current business planning is a mistake.

As part of the 2025 Economic Efficiency Law (Amendment 277), Israel fundamentally changed the taxation of Closely Held Companies ("Hvarot Meatim"):

1. Abolition of the Partnership Exception: The legislative clause that saved the taxpayer in the Nuriel case (Section 62A(a)(4)) has been deleted. Being a "partner" no longer provides automatic immunity from the Wallet Company regime.
2. The New Profitability Test: The new law introduces a mathematical test. If a service company has a turnover of less than NIS 30 million and an operating profitability exceeding 25%, it is presumed to be a tax deferral vehicle.
   • The Consequence: "Excess profits" (above 25%) will be deemed distributed to the shareholder and taxed at personal marginal rates, even if the money remains in the company bank account.
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Implications for Foreign Residents with Israeli Operations

Many foreign residents operate in Israel through private service companies (consultancy, management, IT) to optimize tax liability (paying the 23% Corporate Tax + Dividend Tax, rather than high personal income tax).
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1. Re-evaluate Your Structure
If your Israeli company provides services and maintains high profitability (which is common in service sectors), the "Partner" defense is gone. The ITA will no longer look at whether you function as a partner or an employee; they will look at your Excel sheet. If profitability is high, you are in the net.
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2. The Residency Issue (Eilat Tax Benefits)
The ruling also touched upon tax benefits for residents of Eilat (a Free Trade Zone). The court denied these benefits to the taxpayer, ruling that his "Center of Life" was in Tel Aviv, despite his work in Eilat.
Takeaway: For foreign residents claiming tax benefits based on specific residency status (e.g., "New Oleh" or specific zone benefits), the court applies a strict "Center of Life" test. Having business interests in a location is not enough; you must prove your personal life is centered there.
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3. Action Plan

• Review Profitability: Check if your Israeli service company is projected to exceed 25% profitability in 2025.
• Dividend Policy: Consider distributing dividends or adjusting salary structures to mitigate the risk of "Deemed Dividend" taxation under the new law.
• Documentation: While the court accepted an unwritten partnership in the past, in the current aggressive tax climate, written agreements defining relationships between foreign owners and Israeli entities are mandatory to avoid reclassification.
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Bottom Line

The Nuriel ruling is a victory for the "Old World" of Israeli tax law. In the "New World" of 2025, the Tax Authority has moved from legal definitions to mathematical formulas. Foreign investors must adapt their structures to ensure they don't fall into the new 25% profitability trap.

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