Dear Clients, Colleagues and Friends,

The Israeli government has recently initiated a comprehensive plan to enhance the competitive advantage of Israel’s high-tech sector, focusing on increasing investments, fostering companies’ growth, and expanding multinational companies’ activities in Israel. This initiative (the “Proposal”) follows a government resolution from January 2024, aimed at incentivizing the high-tech industry and maintaining Israel’s position as a global innovation leader. The Proposal, which is still in draft form and has not yet been formally finalized as a governmental resolution, was originally part of the 2025 budget legislation and may now move to a regular legislation track.

Following are the key taxation initiatives included in the Proposal:

• Increasing Tax Certainty for Multinational Corporations: The Proposal includes a plan pursuant to which the Israel Tax Authority (the “ITA”) would publish guidelines, in the form of a new circular, regarding transfer pricing policies for Israeli research and development (or R&D) centers of multinational groups, in the aim of providing a safe harbor based on the cost-plus method. The new circular would effectively put an end to profit-split claims raised by the ITA in corporate income tax audits of R&D centers of multinational groups. The Proposal requires the ITA to publish said circular, introducing a “green route” for a cost-plus method, and providing clear guidelines and conditions that are measurable and quantifiable for multinational groups that are active primarily outside of Israel.

• Encouraging Investments: To stimulate investments in the Israeli market in general, and in the high-tech industry in particular, the Proposal suggests making certain amendments to Israel’s Income Tax Ordinance and Value Added Tax Law which would include:

• Non-Israeli Residents: Eliminating the no-PE condition for Capital Gains Exemption. Under domestic law, non-Israeli residents are generally exempt from tax on capital gains derived from investments in securities of Israeli companies. The exemption is conditioned, however, among other things, on the non-Israeli resident not maintaining a “permanent establishment” (or PE) in Israel to which the capital gains are attributable. A PE in Israel can be triggered, for example, if the non-Israeli resident has a fixed place of business, such as an office space, or engages a dependent agent. In recent years, the ITA took the position that an Israeli office of an investment fund, an Israeli office managing local investments, or even an Israeli local representative conducting investment scouting activities, due diligence work, participating in investment decisions, or filling a board seat, creates a PE that could eliminate the capital gains exemption upon exit. Under the Proposal, the capital gains exemption from investments in certain specified financial assets (such as securities of Israeli high-tech companies) would nevertheless apply, disregarding whether the capital gains are attributable to the non-Israeli resident’s PE in Israel.

• Israeli Residents: Classification of Income as Capital Gains rather than Ordinary Income. The Proposal authorizes the Ministry of Finance to classify certain types of income from investments in specified financial assets by various types of investors as generating capital gains as opposed to ordinary income. This could be relevant, for example, to individuals and non-corporate entities, since capital gains are subject to lower tax rates compared to ordinary income. For example, the legislation may cover “angel investors” who invest in technology companies as a professional business and investors in investment partnerships who do not participate in the management of such partnerships.

• Carried Interest. The Proposal establishes a reduced (flat) 32% tax rate on success fees (carried interest) for Israeli-resident general partners of investment funds linked to such specified financial assets and clarifies that the carried interest is exempt from value added tax in Israel, which is contrary to the current position of the ITA.

• Tax-Deferred Restructurings and M&A Reliefs: In the aim of facilitating transactions involving Israeli high-tech companies which are often implemented through various tax-deferred restructurings or mergers and acquisitions and in which stock consideration may be involved, the Proposal would relax various existing (and often stringent) conditions such as:

• Reducing ownership thresholds required for tax-deferred mergers and amending market value ratios to facilitate mergers (e.g., under current law, a tax-deferred merger requires that the values of the merging companies not exceed 1-9 and the Proposal would broaden that to 1-19).
• Simplifying and facilitating tax-deferred stock-for-stock acquisitions by reducing the requirement that the purchasing entity acquire at least 80% of the target company to benefit from such deferral to 51%.
• Eliminating the existing ‘continuity of interest’ requirement whereby holders of rights in each of the companies participating in a reorganization, immediately prior to the transaction, retain at least 25% of their holdings in the reorganized company for at least two years following the reorganization date.

The Proposal has yet to be formally adopted as a governmental resolution and to be enacted into law, but it is undoubtedly a step in the right direction. We will, of course, keep you posted on all developments and remain at your disposal for planning any existing or future transactions.

Tax Department

Herzog Fox & Neeman