Israel Considers Adopting US Tax Model to Retain Entrepreneurs

Israel is exploring a significant tax reform, potentially mirroring the American Qualified Small Business Stock (QSBS) model, to encourage entrepreneurs and investors to keep their businesses and capital within the country. The proposed reform could exempt individuals from capital gains tax on the sale of startup shares, with potential savings reaching up to $15 million, or approximately 46 million shekels. This initiative aims to counteract the outflow of Israeli entrepreneurs and tech companies, who often face substantial capital gains taxes in Israel even when operating businesses abroad, sometimes necessitating a change in tax residency to benefit from foreign tax advantages. The Ministry of Finance is studying the QSBS model, which offers tax benefits to owners of stock in young companies. Under the proposed rules, entrepreneurs, investors, and employees holding startup shares for at least five years could qualify for full exemption from capital gains tax, within certain limits. The exemption could be phased in, with 50% relief after three years of ownership and 75% after four years. The reform would also impose limits on company asset size, aligning with the U.S. threshold of $75 million. However, the reform may not benefit all tech sector employees. Concurrently, the Tax Authority is considering an increase in the tax rate on income from stock options from 25% to 30%, or capping such payments. Since the QSBS exemption applies to shares, not options, this could create a scenario where founders and investors gain significant tax advantages, while some employees face a higher tax burden. The Ministry of Finance is concerned that the current tax environment, coupled with security instability and political uncertainty, incentivizes businesses to relocate outside of Israel.