How will Israel's new 2025 tax reforms enhance venture capital? - opinion

Israel is set to introduce in the 2025 budget a comprehensive package of tax reforms designed to enhance the attractiveness of its venture capital and private equity ecosystem. 

The proposed legislation aims to simplify tax procedures, provide greater certainty for investors, and maintain Israel's competitive edge in the global innovation landscape.

The draft bill proposes significant changes to how venture capital and private equity funds are taxed, focusing on streamlining approvals and reducing bureaucratic obstacles. 

Currently, tax benefits for these funds are granted through preliminary approvals, a process that will now be replaced with more permanent legislative provisions.

A key feature of the proposed reforms is a new framework for the Israeli Minister of Finance to establish clear conditions for tax exemptions and reductions for foreign investors. 

When making these determinations, the Minister will be required to consider multiple factors, including the economic utility of investments, risk levels, the investor's home country's tax regime, potential state revenue implications, and safeguards against tax avoidance.

For Israeli partners managing investment funds, the bill introduces a reduced income tax rate of 32% on "success fees" - typically earned when a portfolio company is sold at a profit exceeding a predetermined threshold. 

These success fees, defined as a partner's share of investment profits not directly tied to their financial investment, will now benefit from more favorable tax treatment.

The proposed legislation also includes innovative VAT reforms. These include implementing zero-rate VAT on management fees for Israeli fund managers, calculated proportionally to the share of foreign investors in the fund, and providing VAT exemptions on success fees received by Israeli partners managing funds.

An additional significant provision addresses the tax classification of partnership income. 

What would the new bill allow for? 

The new bill would allow for a more flexible classification of investment income, potentially enabling certain earnings to be treated as passive income, such as capital gains, interest, or dividends, rather than business income, thus reducing its tax liability.

Perhaps most notably, the reforms include enhanced protections for foreign investors. The proposed changes would ensure that foreign investors can continue to enjoy capital gains tax exemptions when selling shares in Israeli companies, even if they maintain a permanent establishment in Israel.

These proposed reforms represent a strategic effort to reinforce Israel's position as a global innovation and investment destination. 

By reducing administrative barriers and providing a clearer, more attractive tax framework, the government aims to continue attracting foreign investment in the country's dynamic tech and startup ecosystem.

The proposed changes are part of the 2025 Economic Arrangements Bill and will require final legislative approval before becoming law. 

They signal a continued commitment in Israel to supporting and expanding Israel's reputation as a leading hub for technological innovation and investment.

Adv. (CPA) Ofir Levy, Leading Partner, and Adv. Ofir Paz, Partner, Tax Department both represent Arnon, Tadmor-Levy Law Firm.