Section 3(j) of the Israeli Income Tax Ordinance (ITA) deals with the taxation of "hypothetical interest" arising from the granting of a loan at preferential interest rates. Any interest that is actually lower than the market rate, such as the average interest rate in the economy, creates hypothetical interest, which is equal to the difference between the interest the borrower was supposed to pay and the interest he actually paid.

The provisions of Section 3(j) state that in cases where a loan, including a debt, that was recorded in the books of a business that is managed in accordance with double-entry accounting, was granted without interest or at an interest rate lower than the rate set by the Minister of Finance for this purpose (which is derived from the average cost of credit published by the Bank of Israel) and, at the same time, there are special relations between the borrower and the lender as defined in the provisions of the law, the loan will be considered to generate hypothetical income for the lender according to Section 2(4). Accordingly, the lender will be liable to tax on the difference in interest rates.

**As mentioned, the assumption underlying Section 3(j) is that when a transfer of funds is made between individuals or corporations under preferential terms that are not market terms, this is only due to the close relationship between the parties, which leads to the "flexing" of business and commercial considerations. Therefore, in general, any debt that arises in such circumstances should be considered a "loan", and if no interest is paid on the debt or interest is paid at a rate lower than that set by the Minister of