Incentivizing High-Tech Companies and Investment Funds: Israel’s Draft Income Tax and VAT Regulations

As a rule, foreign residents investing in Israel are exempt from Israeli capital gains tax, unless their activities are considered a business or are attributable to a permanent establishment in Israel. Investment funds that invest in Israel, however, are not necessarily eligible for this exemption, even where their limited partners are passive investors. This distinction may discourage foreign investment in Israel.

Current Practice and the Remaining Legislative Gap

At present, new funds apply to the Israel Tax Authority (ITA) for a tax ruling under the “green track,” which provides tax exemptions and reliefs for foreign investors and fund managers. However, because this track is not based on an explicit statutory authority, the ITA decided to regulate the matter through legislation and regulations.

The proposed Arrangements Law for 2025 initially included an amendment authorizing the Minister of Finance to issue regulations granting tax benefits to investment funds and investors. However, the amendment was subsequently removed from the Arrangements Law and has not yet been enacted. Draft Income Tax and VAT Regulations have nevertheless been published, but their adoption depends on enactment of the enabling legislation. The proposed tax benefits will be subject to the prescribed conditions, registration obligations, and reporting requirements. The principal proposed benefits are outlined below.

Draft Income Tax Regulations

The draft Income Tax Regulations propose several tax benefits for investment funds operating as partnerships, intended to encourage investment in Israeli companies and companies whose assets are predominately located in Israel. Eligibility is subject to the conditions and definitions prescribed in the regulations. Certain tax benefits, for example, are contingent on investment in technology companies. In addition, foreign residents must retain their foreign-resident status at the time they invest in the fund, when the fund invests in the relevant securities, and upon realization.

• Tax benefits to limited partners on profits

The draft regulations provide that a limited partner’s share of profit from the sale of a security held by a partnership will be treated as a capital gain rather than business income, notwithstanding the character of the income at the partnership level. This treatment applies to limited partners who do not participate in managing the partnership.  

In addition, foreign limited partners will be entitled to a capital gains tax exemption under Section 97(b2) or (b3) of the Income Tax Ordinance even where the profit is generated through a permanent establishment in Israel. These tax benefits are not subject to threshold conditions beyond meeting the relevant definitions and reporting obligations.

• Taxation of general partners, foreign residents, and carried interest

The draft regulations also provide that foreign-resident general partners that are not limited partners may apply for a 10% tax rate on income from the sale of securities and carried interest, but not on management fees. In addition, the general partner’s share of partnership income attributable to its capital commitment may be exempt from tax, subject to the prescribed threshold.

The draft regulations also propose an income tax exemption for foreign residents who are not limited partners in respect of income, other than carried interest, from the sale of securities acquired through a qualifying investment in a technology company.

Regarding Israel-resident general partners in qualifying private investment funds, the draft regulations propose that carried interest be taxed at a rate of 27%. Income attributable to the general partner’s capital commitment would be classified as capital gains rather than business income.

Qualifying Private Investment Fund – Eligibility Criteria

Qualifying private investment funds may be eligible for additional tax benefits, if they meet criteria intended to ensure a broad investor base, a high volume of investments, and a significant foreign investment component.

The eligibility criteria include maintaining a permanent establishment in Israel, having at least ten investors, limiting investment in a single company to 25%, meeting a minimum volume of qualifying investments, maintaining at least a 30% foreign-resident limited partner ratio, and complying with limits on each partner’s holding ratio.

Tax Benefits on Interest and Dividends

For qualifying private investment funds, the draft regulations provide that limited partners’ shares of interest and dividends will retain their characterization as interest income or dividend income, rather than being treated as business income, subject to the prescribed conditions.

For qualifying investments in technology companies, the draft regulations provide that foreign-resident limited partners’ shares of interest and dividends will be exempt from tax, provided that the relevant conditions are met.

Draft VAT Regulations – Tax Benefits on Carried Interest and Management Fees

Because the recently published draft VAT Regulations rely on definitions in the draft Income Tax Regulations, eligibility for the proposed VAT benefits will also require compliance with the conditions and definitions set out in the draft Income Tax Regulations:

• The draft VAT Regulations propose that carried interest for management services provided to a qualifying investment fund be fully exempt from VAT.
• For management fees received for management services provided to a qualifying investment fund, the draft VAT Regulations propose that zero VAT apply to that portion of the management fees attributed to foreign partners, i.e., according to foreign residents’ ratio of investments out of the fund’s total investments.

Practical Implications and Next Steps

The regulations remain in draft form, and their finalization depends on the enactment of the enabling legislation. Nevertheless, the proposed changes may affect investment structures, tax treatment, and the profitability of arrangements used by investment funds, foreign investors, and technology companies. Funds and investors should therefore assess how the final conditions and criteria may affect existing and new funds, current and planned investments, and the realization of investments. This assessment will become even more important as the legislative process advances and the regulations are enacted.

The proposed changes to the tax regime may have significant implications for the Israeli capital market and foreign entities looking to invest in Israel. Monitoring the legislative process and reviewing investment structures may help funds and investors prepare for the changes and take advantage of the proposed tax benefits if they are adopted in their final form.

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Adv. Hanna Daher is a partner in the firm’s Tax Department.

Adv. Itay Edelstein is an associate in the firm’s Tax Department.

Barnea Jaffa Lande’s Tax Department advises investment funds, investors, and Israeli and international companies on tax matters relating to investment structures, fund activities, foreign investment, transactions, and ongoing activities. The Tax Department also analyzes the implications of legislative amendments and new tax arrangements for existing and planned investment structures, assesses eligibility for tax benefits, and helps clients align their tax structures with their business and commercial needs