Israel Tax Authority Implements New 13% Profit Tax Rule for Tech Companies

Israel's Tax Authority, under the direction of Shai Aharonovich, is introducing new regulations that will significantly impact the financial operations of foreign technology companies and development centers in Israel. The changes aim to establish uniform ratios for calculating the tax liabilities of multinational corporations and to regulate intellectual property in acquisition deals, according to a report in "TheMarker." A central element is the "cost-plus" model, which will apply a benchmark profitability rate of 13% on local operating expenses, including salaries, rent, and subcontractors, to determine corporate taxes for development centers that do not generate direct revenue in Israel but provide services to their parent companies. This rate reflects the value of Israel's technological workforce.

Additionally, the Tax Authority is enabling a "cost allocation" model for Israeli companies that have been acquired. This model will allow them to share their technology with the acquiring foreign company without immediate capital gains tax on the sale of intellectual property. The primary motivation behind these changes is to create business certainty in the tech sector, which has suffered from inconsistent policies among tax assessors, leading to prolonged disputes and difficulties for international corporations in pricing future deals.

The Tax Authority seeks to maximize tax revenue from the tech industry while establishing a regulated mechanism to prevent legal conflicts and discourage companies from relocating abroad. For high-tech firms, the impact is mixed: the 13% profit margin will increase local operating costs and the current tax burden, with the possibility of global profit splitting in exceptional cases. However, companies agreeing to the new framework will gain eight years of regulatory certainty, avoiding costly discussions and enabling long-term planning.

Recently, Minister of Finance Bezalel Smotrich met with about 20 representatives from leading tech companies, funds, and entrepreneurs to discuss industry challenges, including the strong shekel and the AI revolution. Smotrich emphasized the government's commitment to strengthening the tech sector as Israel's "economic engine" and ensuring its continued leadership. He also commented on the shekel's appreciation, suggesting the Bank of Israel could have acted more decisively, and highlighted government investments in AI infrastructure and human capital.

Tech representatives raised concerns that the strengthening shekel is reducing investment attractiveness and harming local companies' competitiveness, urging for aid and incentives. In response, Smotrich tasked Dr. Shmuel Abramzon, the Ministry of Finance's Chief Economist, with leading a task force to examine the tax system's suitability for the AI era, aiming to foster AI company establishment and investment in Israel.