Executive summary

The Ministry of Finance, the Israel Tax Authority (ITA) and the Israel Innovation Authority (IIA) announced on 2 November 2025 a comprehensive tax reform for the high-tech sector.

The reform aims to create tax incentives, enhance certainty, remove investment barriers, encourage the rapid return of Israelis who had relocated abroad and streamline bureaucratic processes (the Reform).

Additional Tax Alerts will be issued to further elaborate on each component of the reform, including Tax Circular 8/2025 concerning research and development (R&D) centers and the taxation of intellectual property (IP) exits from Israel, as well as the adoption of the Organisation for Economic Co-operation and Development (OECD) Pillar Two framework and the implementation of the Qualified Domestic Minimum Top-up Tax (QDMTT) model to align Israel's incentive regime with global standards.

Key highlights of the reform

Investment funds and institutional investors

On 2 November 2025, a draft of the Income Tax Regulations (Benefits to Investors in Securities or Financial Assets), 2025 was published for public comments. The draft addresses regulating taxation for venture capital, private equity and hedge funds in Israel. The main provisions include:

1. Capital gains tax exemption for foreign investors using a partnership structure
2. Capital gains tax exemption for foreign investors on investments in Israeli tech companies
3. Passive income classification for Israeli passive investors in funds
4. Passive income classification for active Israeli investors in funds (subject to a 10% investment threshold limitation)
5. Preferred tax rate of 27% (plus 3% surtax) on carried interest subject to fund diversification conditions stipulated by regulation, including a 30% minimum of foreign investors, diversification of the investments and a minimum of US$10m invested in Israeli manufacturing companies
6. Reduced withholding tax on interest and dividends for certain fund investors and technology investments

In addition, according to the announcement, a legislative amendment is expected to be published authorizing the enactment of the above-mentioned regulations, alongside clarification of the value-added tax (VAT) treatment applicable to investment funds (yet to be published).

These are expected to stipulate a:

• VAT exemption on carried interest for Israeli and foreign investors
• Fixed VAT formula on management fees based on the fund foreign/Israeli investor ratio

Income tax circular number 8/2025 - Multinational R&D centers and IP valuation

A new income tax circular, number 8/2025 published on 2 November 2025 (the Circular), provides guidance for determining transfer pricing methods in relation to R&D centers operating in Israel and presents a fast-track ruling in relation to intangible property (IP) transfers following acquisition of Israeli companies.

The purpose of the Circular is to enhance certainty of the tax environment in Israel. For this purpose, it establishes (1) an internal control tool for conducting assessments of Israeli companies that provide R&D services to foreign related parties, as well as (2) a framework for issuing tax rulings in situations in which IP is sold after a foreign related party acquires an Israeli company and converts the acquired company into an R&D center.

These cross-border related-party transactions are subject to the provisions of Income Tax Ordinance (ITO) Section 85A and must be carried out under arm's-length conditions, both with regard to the transfer of intangible assets and the provision of services.

Key principles of the Circular include:

1. Pricing method for R&D services in the framework of an assessment

The Circular stipulates that an ITA examination of a change in the transfer pricing method to a method other than the "mark-up on total cost" method will be supervised closely by a representative from the ITA professional division (at different levels depending on the stage of the assessment), subject to several conditions, including:

• The ultimate parent company (holding the parties to the transaction) is resident in a foreign country that is a party to a tax treaty with Israel.
• Israeli residents do not hold 10% or more of the means of control in the ultimate parent company.
• The company's revenues are derived from providing R&D services to related parties abroad.
• The transfer pricing method applied and reported in the tax return (Form 1385) is "mark-up on total cost."
• The company will attach to its annual tax return comprehensive transfer pricing documentation supporting the applied method and notify the ITA at the beginning of the assessment that the company has complied with these conditions.

As stated, this procedure will apply only to claims regarding a change in transfer pricing method (not to the components of the cost base, the level of mark-up, etc.).

In addition, the Circular determines that an increase in the mark-up rate above 14% will also be subject to written approval by the ITA professional division.

2. Fast-track tax ruling — IP sale following equity acquisition

The Circular addresses situations in which a foreign corporation acquires an Israeli company engaged in the development of an intangible asset, as defined under the Israeli Encouragement of Capital Investments Law.

If, following and in close proximity to such an acquisition, the company's intangible property is also sold and transferred to a related entity, and the Israeli company subsequently operates as a limited-risk R&D service provider, a company that meets the conditions set out in the Circular may apply for a specific tax ruling (the Ruling) addressing the valuation of the IP transfer and the transfer pricing of the R&D services to be rendered.

In the Ruling, the ITA will approve a minimum value attributed to the intangible property calculated as 85% of the total consideration paid for the acquisition of the Israeli company, less cash and plus liabilities (including consideration paid to the IIA, as well as employee bonuses even if not recorded on the company's balance sheet). The sale must be completed within 180 days from the equity acquisition closing date. After the sale of the IP, the company will move to an R&D service provider model.

The Circular also provides supporting language regarding the applicability of a 6% capital gain tax rate for the IP exit (instead of 23%).

The Ruling will include a stability clause through the seventh tax year following the closing, subject to continued compliance with the Circular and Ruling conditions.

Alongside the outlined framework, the Circular reiterates ITO Section 85A(d)(1), which allows a taxpayer to apply to the ITA for advance approval that the intercompany transaction pricing is at arm's length for companies engaged in providing R&D services.

In parallel, it remains possible to enter into a bilateral agreement, which requires coordination between the tax authorities relevant to the transaction and the taxpayer, subject to and in accordance with the provisions of the applicable tax treaty.

The Circular applies to tax years open for assessment and up to the tax return filed at the end of the 2029 tax year.

Return of employees to Israel

The reform also addresses the issuance of rules and guidelines regarding the tax aspects applicable to employees returning to Israel after a period abroad, including:

• Guidelines for allocating equity compensation income between Israel and applicable jurisdictions abroad
• Exemption for income generated outside Israel
• Credit mechanism for foreign taxes paid on income that was also subject to tax in Israel
• Introduction of a "green track" for switching from ITO Section 3(i) to ITO Section 102 with respect to equity compensation taxation (a specific tax circular should be published separately)
• Planned legislation to increase residency-determination certainty based solely on presence days in Israel

Implications

The reform presents benefits for multinational groups with operations in Israel. Specifically, the new framework provides enhanced tax certainty and clearer procedures for obtaining advance rulings, enabling companies to proactively manage their transfer pricing and IP structures.

In addition, the new approach regarding capital gains tax exemptions and favorable fund taxation should create a more attractive environment for expanding investments and establishing or scaling R&D and innovation activities in Israel.