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22 January 2021
Israel – known as the 'start-up nation' – has encouraged and attracted inbound foreign investments for many years. Investors looking to invest in Israeli companies may do so by:
Recent years have shown an increased interest and investment activity in Israeli companies by foreign investors, several of which have formed an Israeli corporate venture capital (CVC) fund for this purpose.
Among the primary tools for encouraging inbound investments is the special tax regime for private investment funds. Over the years, the Tax Authority has issued substantial guidance and numerous private rulings under the Income Tax Ordinance, providing significant tax benefits to foreign investors and private investment funds operating in Israel.
This article outlines the income tax arrangements applicable to private investment funds operating in Israel. These arrangements are predominantly based on Income Tax Circulars 9/2018 and 10/2018, which govern the taxation of venture capital funds and private equity funds, respectively.
The special tax regime applicable to private investment funds is currently under review by the Tax Authority and the Ministry of Finance. As such, tax benefits that are available under the existing regime may be adjusted and further criteria for entitlement may be added. However, such changes are not expected to affect the existing arrangements for non-Israeli limited partners.
The principal conditions for beneficial tax treatment for non-Israeli investors regarding their investments in private equity and venture capital funds are as follows:(1)
For purposes hereof:
If all of the above criteria are met, the following will apply to the non-Israeli investors in the fund and in the general partner.
Tax arrangement for non-Israeli limited partners
Income derived from non-Israeli investments (ie, non-Israeli companies or non-Israeli affiliated companies) will be exempt from tax in Israel.
Income derived from venture capital investments (ie, capital gains, dividends and interest) will be exempt from tax in Israel.
Income derived from qualified investments that are not venture capital investments will be taxed as follows:
Tax arrangement for non-Israeli fund managers
Based on the foregoing, and once the fund qualifies for tax benefits, the general partner and the managers of the fund may also be entitled to certain tax benefits. As stated above, the special tax regime applicable to private investment funds is currently under review by the Tax Authority and the Ministry of Finance. As such, tax benefits that are available under the existing regime may be adjusted and further criteria for entitlement may be added.
Taxation of carried interest
Carried interest income attributable to Israeli investments will be subject to tax at the rate of 15% in the hands of non-Israeli fund managers.
Carried interest income attributable to investments in foreign entities will not be subject to tax in Israel.
Notwithstanding the foregoing, non-Israeli general partners and fund managers from a treaty jurisdiction may be eligible for the tax rates set out under the applicable treaty, subject to confirmation of tax residency and beneficial ownership by the Tax Authority.
Taxation of management fees
Income derived from management fees will generally be subject to the regular tax rates set out in the Income Tax Ordinance (up to 50% for individuals and 23% for corporates).
Over the years, the Tax Authority has issued alternative tax arrangements for funds that do not meet the criteria described above, including funds:
The following is a short description of the beneficial tax treatment available in some of these situations.
Funds that have fewer than 10 investors
Income from realisations of qualifying investments will be subject to 15% income tax in Israel.
Income from interest and dividend payments that are derived from qualifying investments will be subject to tax at the lesser of:
Other income that is not derived or accrued from qualified investments will be subject to the tax rates established in the Income Tax Ordinance.
Income derived from non-Israeli companies (ie, non-Israeli or non-Israeli affiliated companies) will be exempt.
Funds with less than $10 million in commitments
A beneficial tax arrangement will be available to funds that are focused on making venture capital investments.
Income from realisations of venture capital investments will be exempt from tax in Israel.
Income from interest and dividend payments will be subject to tax at the lesser of:
Non-Israeli funds investing in Israel without representation in israel
Generally, such a fund will enjoy the same tax benefits as described under "Tax Arrangement for Non-Israeli Limited Partners" above.
Non-Israeli managers of the fund will be entitled to exemption from Israeli tax on their carried interest (as opposed to 15% tax on carry sourced from investments in Israel, for a fund with Israeli representation) and on their management fees.
For further information on this topic please contact Anat Shavit, Ronald Lehmann, Ron Sitton or Yuval Peled at Fischer Behar Chen Well Orion & Co by telephone (+972 3 694 4111) or email (email@example.com, firstname.lastname@example.org, email@example.com or firstname.lastname@example.org). The Fischer Behar Chen Well Orion & Co website can be accessed at www.fbclawyers.com.
(1) Limited partners holding more than 4% of the interests in a fund may not control the entities managing the fund and may not hold more than 10% of the general partner, if they wish to enjoy the tax benefits.
The materials contained on this website are for general information purposes only and are subject to the disclaimer.
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