Quarterly International Tax Update – Israel’s Latest Legislative and Regulatory Developments

We are pleased to share our latest Quarterly Tax Update, summarizing key legislative and regulatory developments in Israel that may be relevant to international businesses and investors. This update highlights recent Israel Tax Authority publications and legislative amendments affecting multinational corporations, R&D centers, investment incentives, corporate restructurings, and transfer pricing. We hope you find this information useful and welcome any inquiries or discussions regarding its implications for your operations.

Professional Position Paper No. 01/2025 – Israel Tax Authority

On March 11, 2025, the ITA’s Employee Options Department published its position paper, addressing the tax aspect of acceleration of vesting periods for employee options during an “exit” (sale of a company) or an IPO. This paper introduces a significant change by adopting the taxpayer’s stance on the "double trigger" mechanism. It clarifies that under a "single trigger" acceleration mechanism—where unvested options fully vest upon an exit or IPO as predefined in the grant terms—there is no violation of Section 102 of the Income Tax Ordinance due solely to the exit or IPO itself, and the resulting gains from selling the shares are taxed as capital gains under Section 102(b). Similarly, for a "double trigger" mechanism—where vesting accelerates upon an exit or IPO combined with the termination of employment due to that event—the paper confirms compliance with Section 102, with taxation varying based on the type of consideration: cash or equity. For cash consideration, if the acquiring company’s share price at the time of receipt equals or exceeds its price at closing, the gain is taxed as capital gains; if lower, the income splits into a portion taxed as employment income (at marginal rates) and the remainder as capital gains. Equity consideration remains fully taxed as capital gains under Section 102(b). However, if acceleration occurs due to employment termination outside an exit or IPO context, the income is classified as employment income, subject to marginal tax rates.

Professional Circular Draft Regarding the Attribution of Income to R&D Centers

The Israel Tax Authority (ITA) periodically publishes professional circulars that provide a comprehensive review of specific topics. As part of the circular publication process, a draft is sometimes released for public reviews to solicit feedback. On February 27, 2025, the ITA issued a draft professional circular focusing on income attribution for Israeli R&D centers serving foreign corporations under a "cost-plus" framework. The draft targets companies fully owned by a foreign ultimate parent in a treaty country, with Israeli ownership not exceeding 10%, whose sole income comes from R&D services—excluding unrelated assets or IP—and who operate under agreements guaranteeing cost reimbursement plus a profit margin. These corporations must meet preferential income criteria under the Law for Encouragement of Capital Investments, confirm in their annual tax filings that profit attribution adheres to OECD guidelines and the cost-plus approach, and provide detailed documentation, such as R&D contracts and transfer pricing studies featuring DEMPE analysis and comparable company data. The draft establishes a structured process for tax assessors to evaluate and, if needed, adjust transfer pricing methods, ensuring changes are systematic rather than arbitrary. Additionally, the draft specifies conditions under which R&D centers can obtain a pre-ruling allowing the use of the "cost-plus" model for an agreed period of eight years, and it offers options to request an Advance Pricing Agreement (APA) for the Israeli company’s compensation or pursue a Bilateral Advance Pricing Agreement (BAPA) for cross-border transfer pricing arrangements.

Israel Tax Authority Circular 02/2025 – Tax Incentives for Investments in R&D Companies

The Israel Tax Authority's (ITA) Circular 2025/02 serves as a professional framework for implementing the Law for the Encouragement of Knowledge-Intensive Industry (Temporary Provision), 2023. This initiative is designed to strengthen Israel’s high-tech sector by attracting private investment and encouraging early-stage technological innovation. The main points of the circular will be reviewed below.

As part of a new initiative, the ITA is offering a temporary tax incentive to encourage private investment in early-stage Research & Development (R&D) companies. Investors who acquire shares in Israeli R&D companies may be eligible for a tax credit of up to ILS 4 million per company, provided they retain the shares for a minimum period of three years. Furthermore, investors who sell shares of a Preferred Technology Company and reinvest in an R&D company up to 4 months before the sale, or within 12 months after the sale, can defer capital gains tax, with a maximum reinvestment amount of ILS 5.5 million.

To be eligible for the tax profits, the R&D company must be a private Israeli entity focused on technological innovation, and the investor must not have previously held more than 25% of the company before making the investment. The tax incentive is subject to rigorous reporting and compliance standards, and failure to adhere to these requirements may result in the forfeiture of tax benefits and additional liabilities.

Additional Relief in Certain Reorganizations  

As a general rule, the transfer of assets between companies constitutes a tax event triggering capital gains tax under Israeli law. The Income Tax Ordinance allows for structural changes such as mergers and splits with deferred tax liability, subject to the fulfillment of certain conditions.

The recently promulgated legislation introduces a comprehensive framework of regulatory measures aimed at facilitating structural reorganizations and alleviating previous restrictions, thus providing enhanced flexibility for mergers and corporate reorganizations. It reduces the ownership threshold for tax-exempt share-for-share mergers from 80% to 70%, relaxes the permissible merger size ratio from 9:1 to 19:1 (with the minimum stake for smaller company shareholders decreased from 10% to 5%), and abolishes the prerequisite that shareholders retain 25% of rights following restructuring. Furthermore, the legislation eliminates the mandate to finalize construction within five years when transferring real estate to a real estate entity, elevates the allowable portion of  cash consideration in mergers from 40% to 49%, and expands the size ratio for corporate splits from 1:4 to 1:9, thereby fostering greater operational adaptability—such as in vertical divisions of partnerships—while preserving associated tax advantage.

Income Tax Circular 1/2025 – Ultimate Parent Entity Report (CBCr)

On February 11, 2025, the Israel Tax Authority Published Income Tax Circular No. 1/2025 regarding transfer pricing – Amendment 261 to the Income Tax Ordinance – Ultimate Parent Entity Report (CbCR). The circular addresses the reporting obligations applicable to Israeli resident entities that are part of a multinational group with consolidated annual revenues exceeding 3.4 billion ILS (equivalent to EUR 750 million) in the year preceding the tax year. The CbCR report format is detailed in Form 1685, which aligns with OECD guidelines, and the deadline for submission is no later than 12 months after the end of the tax year of the group’s ultimate parent entity. According to the circular, when the ultimate parent entity of the multinational group is an Israeli resident, the group may submit the report in Israel or appoint an alternative parent entity to file the report in another country, provided there is a competent authority agreement with that country and subject to notification of the Tax Authority Director and submission of proof of filing in the other country within one year from the end of the relevant tax year. The circular addresses, among other things, cases where a multinational group owns an Israeli company, but its ultimate parent entity is a non-Israeli resident. It clarifies the conditions under which the Tax Authority Director may require an entity within the group to submit a CbCR report in Israel. Additionally, it provides technical instructions for submitting the report via the Automatic Exchange of Information system (AEOI Portal).