Israeli Tax Authority Reviews Highly Successful Corporate Profit Reform Amid Market Distortions

Israel's Tax Authority is reassessing 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 rent out real estate. This disparity has skewed the market, particularly harming the office real estate sector, which faces a risk of excessive cooling. Ahead of the upcoming Arrangements Law, tax officials are considering solutions to ease restrictions, potentially allowing taxed companies to invest more freely in rental properties, though no decisions have been finalized.

The reform, initiated in late 2024 under then-Finance Ministry Director Shlomi Heisler, aimed to close loopholes in Israel's two-tier corporate tax system. It targeted "shell companies" used to defer taxes indefinitely by accumulating undistributed profits, which accounted for about 20% of such profits and caused an estimated annual revenue loss of 5 to 6 billion shekels. The reform unexpectedly doubled projected tax revenues, reaching 15 to 20 billion shekels in its first year, contributing to a 14% overall increase in tax collection in 2025.

However, the law's exemption for companies that develop and sell real estate, contrasted with heavy taxation on rental income, has led to market distortions. Contractors and developers warn that the office rental market is particularly affected. Finance Minister Bezalel Smotrich acknowledged the need for adjustments, stating, "There is no reason for lawyers to buy investment apartments through companies and avoid paying tax," but emphasized that the goal was not to suppress economic activity.

Former Finance Ministry Director Heisler praised the reform's success in closing tax avoidance but admitted the real estate investment aspect requires refinement. Industry representatives note that the anticipated reinvestment of withdrawn funds into housing was limited by purchase taxes, with negative effects mainly seen in the rental sector.

Given Israel's rising debt-to-GDP ratio, soaring interest payments, and increased defense spending, the government is unlikely to broadly ease tax burdens on capital owners in the near term. Any future relief is expected to focus on wage earners rather than wealthy shareholders. The upcoming Arrangements Law may include minor adjustments but is expected to prioritize revenue expansion over cuts.