Foreign tax credit
Double taxation is avoided by way of a foreign tax credit mechanism that also applies unilaterally in the absence of an applicable DTT. The foreign tax credit is limited to the Israeli corporate tax payable with respect to the same income. Foreign-sourced income is divided into 'baskets' (i.e. categories) on the basis of the income source (e.g. dividends, business income), and a particular credit limitation applies to each basket. Excess uncredited foreign income can be carried forward for the subsequent five tax years.
Preferred Enterprise (PFE) regime
PFE status, which provides for cash and tax benefits, may be granted under the Law of Encouragement of Capital Investments (‘the Law’) to enterprises that meet relevant criteria. In general, the Law provides that projects are considered ‘preferred’ if the enterprise will contribute to the development of the productive capacity of the economy, absorption of immigrants, creation of employment opportunities, or improvement in the balance of payments.
Eligible income (qualifying PFE income)
In order to qualify as a PFE, a company must generate ‘preferred income’, as defined in Section 51 of the Law as income that was produced or arose in the course of the enterprise's ordinary activity from one or more of the below types of income:
- Income from the sale of products manufactured in that factory.
- Income from the sales of products that are semiconductors produced in another factory, which is not owned by a relative of the owner of the factory, according to know-how developed by the factory.
- Income from granting permission to use know-how or computer software developed by the enterprise, as well as income from royalties received for the said use that the Director of the Israeli Tax Authority approved is connected to the productive activities of the enterprise in Israel.
- Income from services connected to sales as stated in (i) and (ii) above, and also from services connected to the right to use know-how or computer software or to the royalties stated in (iii).
- Income from industrial R&D for a foreign resident, provided there has been given an approval from the Director of the Department of Industrial Research and Development.
Marketing and economic qualifying factors
In order to qualify for grants or tax benefits under the Law, the Law requires that the enterprise meets one of the following conditions each year:
- Its main activity is bio-technology or nano-technology (an approval in this regard should be received from the Director of the Department of Industrial Research and Development prior to approval of the PFE).
- Its revenue during the tax year from sales in a specific country or separate customs duties territory does not exceed 75% from its total revenue for that tax year.
- 25% or more of its revenue during the tax year is derived from sales in a specific country or in a separate customs duty territory that has a population of at least 14 million.
Corporate tax rates
The PFE corporate tax rate is 7.5% for operations in ‘development area A’ and 16% for operations outside development area A.
R&D centres will not be entitled to any reduced corporate tax rate if the direct or indirect controlling shareholders or the direct or indirect beneficiaries (entitled to 25% or more of the income or profits of the R&D centre) are Israeli residents.
Dividend WHT rate
The WHT rate applicable to dividends from PFE profits is 20%, which may be reduced under certain tax treaties.
Special Preferred Enterprise (SPFE) regime
Key eligibility conditions
The SPFE regime is intended for very large companies with material investments in productive assets, R&D, or in providing new employment opportunities. A company must demonstrate that it will greatly contribute to the Israeli economy to qualify for the SPFE regime.
To qualify, an Israeli company must meet certain conditions, such as having SPFE annual revenue greater than or equal to ILS 1 billion and being part of a group of companies that generates annual revenues greater than or equal to ILS 10 billion in the same industrial sector in which the Israeli company operates.
Corporate tax rates
The SPFE corporate tax rate is 5% for operations in development area A and 8% for operations outside of development area A for ten years. After ten years, the PFE tax rates shall apply unless the company has a new investment program that requalifies the company again for SPFE status.
Dividend WHT rate
The WHT rate applicable to dividends from SPFE profits continues to be 20%, which may be reduced under certain tax treaties.
Preferred Technology Enterprise (PTE) regime
Key eligibility conditions
To be eligible for the PTE regime, a company must engage in the technology sector and be part of a group of companies with aggregate annual revenues less than ILS 10 billion and meet one of the following two tests:
- The company's average R&D expenses in the three years prior to the current tax year must be greater than or equal to 7% of its total revenues or exceed ILS 75 million per year. The company also must satisfy one of the following conditions:
- At least 20% of company's employees are R&D staff or the company has at least 200 R&D employees.
- A venture capital fund has invested at least ILS 8 million in the company and the company has not changed its field of business since this investment was made.
- During the three years prior to the current tax year, the company's revenue grew on average by 25% in relation to the preceding tax year and the revenue was at least ILS 10 million in each year.
- During the three years prior to the current tax year, the company increased its number of employees each year by an average of 25% in relation to the preceding tax year and the company had at least 50 employees in each tax year.
- The company obtained an approval from the National Authority for Technological Innovation (formerly known as the Office of the Chief Scientist).
Qualifying PTE income is such income that is derived by the company in the ordinary course of its business from preferred intangible assets that are wholly or partially owned by the company or that the company has a right to use and includes, inter alia, income from the following sources:
- Use of the intangible asset.
- Services based on software.
- Products produced by the company using a qualifying intangible asset.
- Accompanying or supporting services to computer software or a product that is directly connected to the qualifying intangible asset.
- R&D services that do not exceed 15% of the company's total income.
- Other types of income that will be included by the Finance Ministry.
Income that is not treated as qualifying income includes, inter alia, the following:
- Income attributed to production.
- Income from an intangible asset, which does not qualify as a preferred intangible asset (detailed definitional rules apply), that is used for marketing purposes.
- Additional types of income to be specified by the Ministry of Finance.
Detailed definitional rules apply.
Corporate tax rates
Under the PTE regime, reduced corporate tax rates of 7.5% for operations in development area A or 12% for operations outside of development area A shall apply. These corporate tax rates shall apply only with respect to the portion of intellectual property (IP) developed in Israel, based on a nexus approach.
Capital gain on sale of IP
Companies that sell IP to a related foreign company will qualify for a reduced 12% capital gains tax rate, provided that the company acquired the IP from a foreign company after 1 January 2017 for at least ILS 200 million, subject to the approval of the National Authority for Technological Innovation.
Dividend WHT rate
A reduced 4% WHT rate may apply to dividends paid to a foreign parent company holding at least 90% of the shares of the distributing company.
For other dividend distributions, the WHT rate shall be 20%, which may be reduced under certain tax treaties.
Special Preferred Technology Enterprise (SPTE) regime
Key eligibility conditions
To be eligible for the SPTE regime, a company must meet the eligibility conditions of a PTE above and be part of a group of companies with aggregate annual revenues of at least ILS 10 billion.
Corporate tax rates
Under the SPTE regime, a reduced corporate tax rate of 6% shall apply, subject to detailed qualifying rules. The reduced tax rate shall apply only with respect to the portion of IP developed in Israel based on a nexus approach.
Capital gain on sale of IP
Companies that sell IP to a related foreign company will qualify for a reduced 6% capital gains tax rate, provided that the company developed or acquired the IP from a foreign company after 1 January 2017, subject to the approval of the National Authority for Technological Innovation.
Dividend WHT rate
The dividend WHT rates are the same as under the PTE regime, discussed above.
Approved Enterprise (AE) and Benefitted Enterprise (BE) regimes (for companies established prior to 2011)
The AE and BE regimes were tax incentive programs granted to operations qualifying under the Law prior to the Law's amendments in 2005 and 2011. As some companies may still be operating under these prior regimes, we set out below certain key tax highlights.
Reduced tax rates
In addition to financial incentives for the establishment or expansion of an AE/BE, various tax incentives apply when a new AE/BE or expansion thereof is operational.
The reduced tax rates generally apply for a seven-year benefit period (or a ten-year period in certain cases of local companies established in development area A or in the case of a foreign investor company, see below), commencing with the year in which the AE/BE first generated taxable income.
Generally, this seven or ten-year period of benefits is limited to 12 years from the year of implementation. For AE plans governed prior to the 2005 amendment to the Law, the period of benefits cannot extend beyond 12 years from the year the enterprise commenced its operations or beyond 14 years from the year in which approval of status as an AE was granted, whichever is earlier.
Locally owned companies
Income derived by a company from an AE/BE during the maximum seven-year period of benefits is generally subject to corporate tax at a rate of 25%.
A WHT rate of 15% (subject to a possible reduction under a tax treaty) applies to dividends paid from profits of an AE/BE earned during the benefits period if distributed either during the benefits period or during the subsequent 12 years.
Foreign investors’ companies (FICs)
A company that qualifies as an FIC is entitled to enhanced tax benefits on AE/BE income. In general, an FIC is a company having more than 25% of its share capital (in terms of rights to shares, profits, voting, and the appointment of directors) and its combined share capital and investor loan capital owned by foreign residents. To qualify for FIC status, a foreign investor must make an investment in the company of at least ILS 5 million.
An FIC benefits from reduced corporate tax on the profits of an AE/BE for a period of ten years (instead of seven years) commencing with the first year in which taxable income is generated. The total period of benefits is restricted as discussed above. The reduced corporate tax rate depends on the level of foreign ownership as shown below:
|Percentage of foreign ownership||Corporate tax rate (%)|
|Over 25% but less than 49%||25|
|49% or more but less than 74%||20|
|74% or more but less than 90%||15|
|90% or more||10|
Dividends paid by an FIC out of the profits of its AE/BE are subject to tax in the hands of the recipient at the rate of 15% (subject to a reduced tax rate under an applicable tax treaty), without limitation as to their distribution date, provided the dividends are distributed out of AE/BE profits derived during the benefits period.
Alternative system of tax benefits (tax holiday)
Companies with new or expanding AEs/BEs were entitled to elect to forego all government cash grants and receive, instead, a total exemption (i.e. tax holiday) from corporate tax on undistributed profits of the AE/BE for ten years in development area A, for six years in development area B, and for two years in development area C. The area of incentive is the area in which the company’s facilities are located.
The tax holiday provides an Israeli tax exemption so long as the AE/BE profits generated in the exemption period are retained within the company. Should a subsequent distribution of such profits occur, corporate tax and dividend WHT is imposed on the income distributed, at the rates which would have been applicable if the tax holiday had not been elected (i.e. 25% or at a lower rate if the company is an FIC with a foreign ownership percentage of 49% or more during those years).
Israeli companies who distribute tax-exempt profits generated in their Approved and Benefitted Enterprise regimes of the Encouragement Law ('trapped profits') are generally subject to a claw-back of the corporate tax deferred on those profits at rates of 10% to 25% upon distribution. In order to encourage companies to release their 'trapped profits' accumulated until 31 December 2020, the Budget Law passed in November 2021 included special legislation (the Trapped Profits Law) that allows 'trapped profits' upon distribution to be entitled to a reduction of up to 40% of the corporate tax rate but not less than a 6% corporate tax rate. This applies for distributions made during a one-year period starting from 15 November 2021.
The Trapped Profits Law, however, eliminates the ability of companies upon distribution of profits to determine that the pool of profits being distributed should not be attributed to tax exempted profits, which had prevented the triggering of the claw-back of tax on the distribution. Under the new legislation, effective for profits distributed from 15 August 2021, all dividends distributed by a company that have 'trapped profits' shall be required to recognise a portion of the dividend as being sourced from the 'trapped profits', which shall trigger the claw-back of corporate tax. The determined amount shall be based on the proportion of 'trapped profits' to all company profits available for distribution.
Under certain anti-avoidance provisions applicable to tax holidays, amounts directly or indirectly paid or credited by an AE to a relative, a major shareholder, or to a related entity controlled by either a relative or a major shareholder may be treated as a deemed taxable distribution of profits by the AE.
Ireland track and strategic investment track
For companies having an AE/BE in development area A that seeks to distribute dividends while maintaining a low company and dividend tax burden, there was an ‘Ireland track’ under which the aggregate Israeli corporate and dividend WHT for a foreign resident shareholder is 15% and for an Israeli resident shareholder is 24.8%. This track is in contrast to the standard alternative benefit track discussed above, which provides a tax holiday, provided that profits remain undistributed.
Furthermore, a ‘strategic investment track’ allowed for an exemption during the benefit period from corporate tax and dividend WHT for a company having (depending on its location within area A of the country) very significant investment and revenue levels. This means that during the benefits period, a company eligible for benefits from income accrued under this track will have no tax liability whatsoever for its productive activity arising from such investment and for the distribution of profits. Detailed rules apply to these tracks.
Research and development (R&D) incentives
Deduction of R&D costs
Under special relief provided under the ITO, which was enacted for the purpose of encouraging taxpayers to invest in R&D activities, R&D costs can generally be deductible for tax purposes even when they represent capital costs.
The ITO provision generally distinguishes between two types of investors in R&D projects:
- The R&D project is conducted or sponsored by the owner of an enterprise in the fields of industry, agriculture, transportation, and energy, and it is intended to develop this enterprise.
- The R&D costs are borne by a taxpayer that is not the owner of an enterprise in the above-mentioned fields or the taxpayer participates in R&D costs of another developer in consideration for a reasonable return, when such R&D projects also enjoy government grants.
In regard to the first group of taxpayers, the R&D expenses shall be deducted in the tax year incurred when such expense has been approved as an R&D expense by the relevant government department (the approval in regard to industrial related projects is generally granted by the National Authority for Technological Innovation [previously called the Office of the Chief Scientist]). When such approval is not obtained, the expense shall be deducted over three tax years.
The R&D expenses incurred by the second group of taxpayers shall generally be deducted over two tax years. The deductible expenses allowed to a participant in R&D costs of another developer generally may not exceed 40% of the taxable income of the investor in the year in which the expenses had been incurred.
Amortisation of acquisition amount
A special law that encourages investment in Israeli high-tech industry provides different tracks that allow for amortisation of the acquisition amount further to detailed rules (the Angel's Law).
The Angel's Law currently contains three tracks.
Under Track One, for acquisitions between 1 January 2011 and 31 December 2019, an Israeli tax resident company that acquires a controlling interest in a private Israeli company that meets certain R&D activity levels shall be entitled to amortise its acquisition amount (i.e. consideration paid for shares less the purchased company's positive equity capital if any) from its taxable income equally over five years beginning with the tax year following the acquisition. Entitlement to this deduction is subject to the fulfilment of detailed qualifying conditions, which include, inter alia, that both companies have AE/BE/PFE plans in the year of acquisition, meet certain R&D investment levels, employ a certain prescribed percentage of employees having academic degrees in certain qualifying fields, and for the first three years of the amortisation period the R&D expenses of the acquired company are incurred for its own company or that of the purchasing company and at least 75% of such expenses are incurred in Israel. Detailed rules apply.
Track Two applies to single investors that invest in seed companies, and applies to investments between 1 January 2011 and 31 December 2019.
Track Three applies to single investors that invest in early stage companies, and applies to investments between 1 January 2016 and 31 December 2019.
Under Tracks Two and Three, individual investors who invest in high-tech Israeli companies (which meet the definition of ‘qualifying investment’) will be entitled to deduct their investments, over three years up to ILS 5 million in each company, as an expense against their total taxable income. This allows early recognition of the investment as a current expense (instead of recognising it on the date of realisation of the shares of the investee company). The most significant advantage inherent in the Angel's Law is the investor's ability to offset its investment against income at higher tax rates, such as employment income. The qualifying conditions differ for Tracks Two and Three. Detailed rules apply.
Tax credit for donations
A tax credit is granted in respect of donations to approved state and charitable institutions aggregating at least ILS 190 (for 2022) in a tax year. The donor is allowed a tax credit equal to the amount of the contribution times the corporate tax rate applicable during the year, provided the amount eligible for the credit does not exceed the lower of the following: (i) 30% of the corporation’s taxable income in that year or (ii) ILS 9,517,000 (in 2022). The above figures are adjusted each year according to the CPI. Excess unused tax credits may be carried forward for three years, subject to detailed rules.
Incentive to promote foreign investment in Israeli corporate bonds
In order to promote foreign investment in the Israeli corporate bonds market, there is an exemption from tax with respect to interest income received by foreign investors on their commercial investments in Israeli corporate bonds traded on the Tel Aviv stock exchange (TASE). The exemption is not granted to a foreign investor that has a PE in Israel or is related to, or holds 10% more of the means of control in, the investee company. In addition, in order for the exemption to apply to a foreign investor that has ‘special relations’ with the investee company, regularly sells products to or provides services to the investee company, or is employed by the investee company, the investor must prove that the interest rate on the corporate bond was determined in good faith.