Israeli Tax Authority Reviews Overly Successful Corporate Profit Reform Amid Real Estate Concerns

Israel's Tax Authority is reconsidering the corporate profit retention reform, a flagship policy of the current government that has generated billions in revenue. The law exempts companies that buy land, build on it, and sell from corporate tax but heavily taxes companies that purchase and lease real estate, particularly affecting the office sector. This has caused market distortions, with developers favoring construction and sale over investment in income-generating properties, risking a slowdown in the office rental market.

The reform, initially part of the 2026 state budget and based on extensive professional work, doubled expected state revenues, surprising even its architects. However, the tax authority plans to review the reform ahead of the upcoming Arrangements Law, considering possible relief measures to encourage investment in office real estate. Discussions are ongoing, but any changes face challenges due to the state's reliance on this tax amid rising debt-to-GDP ratios and soaring interest payments.

The reform originated from a 2024 report led by then-Finance Ministry Director-General Shlomi Heisler, addressing the two-tier corporate tax system and aiming to prevent tax deferral through "shell companies" that accumulate profits without distributing dividends. The reform targets such companies, which hold about 20% of undistributed profits, causing an estimated annual revenue loss of 5 to 6 billion shekels. Actual revenues from the reform reached 15 to 20 billion shekels in 2025.

Criticism has emerged from sectors like construction and real estate, with Finance Minister Bezalel Smotrich acknowledging the need for adjustments to avoid harming market activity. Heisler defended the reform as a major success but admitted the real estate investment aspect requires fine-tuning. Contractors report that the reform's impact on income-producing real estate, especially rentals, has been negative, with expectations that the upcoming review will allow only limited relief.

Given Israel's increased government spending since the war, rising debt levels, and nearly tripled defense budget, the 2027 budget is expected to include tough tax measures. Experts suggest any tax relief will likely focus on wage earners rather than capital owners. The tax authority's review aims to balance maintaining revenue with addressing market distortions caused by the reform.