Withholding Tax at Source — A Complete Guide for the Self-Employed and Employees

What is Withholding Tax at Source?

Withholding tax at source is an accounting mechanism in which a payer (employer, contractor, bank or other entity) deducts a certain amount from a payment being transferred to a recipient and transfers it directly to income tax in the name of the recipient. This is essentially an advance tax payment, made in the name of the person receiving the payment.

Withholding tax at source serves two main purposes: (1) ensuring periodic tax collection for the tax authority, and (2) reducing tax liabilities at the end of the year for individuals or the self-employed. Typically, the withholding serves as a "prepayment" of tax that will be due in the annual report.

As long as you are paying withholding tax, you are essentially paying income tax in installments throughout the year, rather than paying a large sum at the end of the calendar year. This eases cash flow management and prevents large tax debts during certain periods.

Who is Required to Withhold Tax at Source?

Withholding tax at source applies to a variety of payer and recipient categories:

• Employers — are required to withhold tax at source from employee salaries and contractor payments according to rates set by the Tax Authority.
• Contractors and Self-Employed Individuals — when paying a subcontractor or independent supplier, may be required to withhold tax at source from the payment.
• Banks and Financial Institutions — withhold tax at source on interest, dividends, and other investment income.
• Government and Public Institutions — make withholdings on various payments to suppliers and contractors.
• Companies and Individuals Engaged in Real Estate Income — may be required to withhold tax at source on rental transactions or sales.

In each case, the withholding is performed in accordance with applicable law and regulations of Income Tax, and depends on the type of income, marital status, and tax benefits of the recipient.

How is Withholding Tax at Source Calculated?

Calculation of withholding tax at source depends on several factors:

• Type of Income — wages, commissions, interest, dividends, and any other type of income may have a different withholding rate.
• Tax Rate — the Tax Authority sets different rates in accordance with law. For example, wages may be at a rate of 10% to 50% depending on estimated annual income, while bank interest may be at a fixed rate.
• Personal Tax Benefits — if you have benefits (such as a tax discount, exemption for children, or minimum income), they may affect the withholding rate.
• Capital Declaration — in certain cases, a capital declaration or identification document may be required to reduce the withholding rate.

A professional accountant (CPA) can help you calculate the correct withholding, file required tax returns, and ensure that you pay exactly the amount required by law.

Difference Between Withholding Tax and Regular Income Tax

Withholding tax is an advance tax payment, while income tax is the final calculation of the tax you owe on all your income for the year. The main differences are:

• Payment timing — Withholding tax is paid throughout the year (when you receive income), while final income tax is calculated in an annual report at the end of the year.
• Responsibility — The withholding payer (employer or contractor) is responsible for transferring the funds to the tax authority, not the recipient.
• Money refund — If withholding taxes were higher than the tax you actually owe, you are entitled to a tax refund in the annual report.
• Withholding shortfall — If withholding taxes were too low, you may have an additional tax liability at the end of the year.

This is why it is important to track withholding taxes throughout the year and file an accurate annual report — to ensure that you pay the correct tax, not more and not less.

Tax Rights and Refunds for Withholding Tax

One of the most important matters is your right to a tax refund if withholding tax deductions were too high.

When are you entitled to a tax refund?

You are entitled to a tax refund when:

• The total withholding tax deductions throughout the year exceed the tax you actually owe in your annual report.
• You are entitled to tax benefits that were not taken into account in the withholding (such as tax discounts, child exemptions, or professional expenses).
• Your income decreased during the year and withholding tax was based on higher income.
• You are a new immigrant or foreign resident with a different tax status.

How to obtain a tax refund?

To obtain a tax refund, you must file an annual report with the income tax authority. In the report, you report all your income, withholding tax deductions you made, and your tax benefits. The tax authority will calculate the actual tax you owe, compare it to the deductions you made, and convert the difference into a refund or additional debt.

A professional accountant can prepare your annual report, ensure that all your benefits are calculated, and help you obtain the maximum possible tax refund within the legal conditions.

Filing deadlines and processing

Annual reports are typically filed during a specific period in the new year. Tax refunds are processed after the tax authority examines your report, and this may take several weeks or months depending on the tax authority's workload. Generally, tax refunds are processed to a bank account you specified in your report.

Withholding Tax for Self-Employed Persons and Business Owners

Self-employed persons and business owners (exempt business operator, licensed business operator, and companies) may encounter withholding tax in several situations:

Receipt of Income with Withholding Tax

If you are self-employed and receive income from a contractor or other entity, they may withhold tax from their payment to you. This may occur when you serve as a subcontractor, supplier, or consultant. The contractor or employer is responsible for withholding the tax and remitting it to the tax authority on your behalf.

Performing Withholding Tax as an Employer

If you are a business owner and receive subcontractors or employees, you may be required to withhold tax from your payments to them. This depends on the type of contractor (employee, independent contractor, etc.) and your employment relationship with them.

Reporting in Annual Return

In an annual return, self-employed persons and business owners report all withholding taxes they performed (if they are payers) and all withholding taxes performed on them (if they are recipients). This is important for calculating their final tax liability.

Withholding Tax for Employees

Employees are the most common category of individuals subject to withholding tax. Every employee who receives a salary from their employer is subject to withholding tax deducted from their salary.

How Does It Work?

Each month (or at other payment intervals), the employer calculates the tax you owe based on your income, deducts it from your salary, and transfers it to the tax authority. The salary you receive is the gross salary minus various deductions (tax, national insurance, pension, education fund, etc.).

Tax Refund for Employees

At the end of the year, you are entitled to file an annual tax return and verify whether withholding tax deductions were correct. If you are entitled to tax benefits that were not taken into account (such as child allowances, professional expenses, or charitable donations), you may be entitled to a significant tax refund. Many employees receive tax refunds at the end of the year because withholding tax deductions were too high.

Payslip and Deductions

Every payslip you receive should detail the withholding tax deducted by your employer. It is important to keep these payslips, as they serve as evidence of your deductions in your annual tax return.

Practical Scenarios: Examples of Withholding Tax

Below are several examples demonstrating how withholding tax works in practice:

Example 1: Employee with Tax Refund

Dan is an employee earning NIS 10,000 per month. His employer withholds an average of NIS 1,500 per month as withholding tax. At the end of the year, Dan filed an annual report and discovered he was entitled to a deduction for two children that was not taken into account in the withholding. After calculating his final tax liability, it turned out that Dan had overpaid NIS 2,000 in withholding taxes. Dan received a tax refund of NIS 2,000.

Example 2: Self-Employed Individual with Withheld Income

Sarah is a self-employed consultant providing consulting services. In a given month, she received a payment of NIS 5,000 from a large contractor. The contractor withheld NIS 500 (10%) as withholding tax and paid Sarah NIS 4,500. At the end of the year, Sarah reported all her income and withholding taxes in an annual report. Based on her tax entitlements, she is eligible for a tax refund.

Example 3: Subcontractor with Tax Debt

Yossi is a subcontractor in the construction field. He received payments from several main contractors, each of whom withheld withholding tax at different rates. At the end of the year, Yossi filed an annual report and discovered that the withholding taxes were too low relative to his total income. Yossi owes an additional tax debt of NIS 1,500 that he must pay to the Tax Authority.

Tax Withholding at Source and Annual Tax Planning

Tax withholding at source is an important part of annual tax planning. To plan your taxes effectively, it is important to:

• Monitor Deductions — Keep pay slips, invoices, and payment statements to track tax withholdings at source throughout the year.
• Check Entitlements — Identify all tax entitlements you may have (discounts, exemptions, professional expenses, etc.) that may affect the calculation of tax withholding at source.
• Plan Ahead — If you foresee a significant change in income or family status, consider speaking with a certified accountant to update your tax withholding at source.
• Submit Annual Report on Time — Submitting your annual report on time ensures you receive a tax refund quickly and avoid late payment penalties.
• Seek Professional Advice — A professional certified accountant can help you plan your taxes efficiently and ensure you pay the correct amount.