The memorandum of law to amend the Income Tax Ordinance

The memorandum of law to amend the Income Tax Ordinance

Recently,  the Ministry of Finance published a memorandum of law proposing  amendments to the Income Tax Ordinance, which includes amendments that are expected to be included in the economic plan for 2025, the purpose of which is to increase Israel's competitive advantage in investments, company growth and the expansion of international companies (in the high-tech industry in particular), by providing certainty and removing barriers in taxation ("Memorandum of Law").
The proposed amendments are focus on taxation arrangements applicable to structural changes and  taxation of investment activity in Israel, as will be detailed below:

The taxation arrangements applicable to structural changes

As part of the Memorandum of Law, amendments to the Income Tax Ordinance are proposed regarding structural changes exempt from tax, aiming to remove barriers regarding certain structural changes, which are an important tool in the business sector. These amendments also expand the range of activities that may qualify for non-taxable structural changes.
The proposed changes include inter-alia:

• Determining that in a merger through the exchange of shares (where shareholders of the transferring company exchange their shares for shares in the receiving company), at least 70% of the rights in the transferring company will be transferred to the receiving company, compared to the current requirement of at least 80%.
• It is proposed to ease the conditions of size ratios, which are basic conditions for qualifying a tax-exempt merger. Instead of requiring that the market value of each of the companies participating in the merger not exceed nine (9) times the market value of another company participating in the merger, it will be stipulated that the market value of each of the participating companies in the merger will not exceed nineteen (19) times the market value of another company participating in the merger. According to this change, the total rights of all the shareholders in the companies involved in the merger will be, at the time of the merger, at least 5% of the market value of the rights in the acquiring company (instead of the current requirement of 10%). However, to prevent abuse of this relief and to ensure that there is business and economic rationale for the merger, and that tax avoidance or inadequate tax reduction are not among the purposes of the transaction, the merger will require the approval of the Director of the Tax Authority according to the provisions of Section 103C of the Ordinance.
• It is proposed to abolish the existing limitation on merger, split or assets transfer, which requires a minimum holding of 25% of the rights in the receiving company by the owners of the transferring rights, for the required period following the structural change (usually two years).
• Currently, when transferring real estate as part of a structural change, there is a requirement to complete construction within 5 years from the date of the change, and if the construction is not completed, the structural change is retroactively canceled, including the exemption granted as part of it, and both the company and its shareholders become liable for taxes on the sale of the assets. As part of the memorandum of the law, it is proposed to cancel this requirement, thereby removing the requirement to complete the construction within 5 years for real estate transferred as part of a structural change.

Taxation of investment activity in Israel

As part of the Memorandum of Law, amendments are proposed regarding the taxation of investment activity in Israel, aiming to provide investors with certainty and encourage investments in Israel, in particular investments made by foreign residents through investment funds operating in Israel.

Currently, non-residents can receive a tax exemption on their investments in Israeli companies, provided that the income is generated through an investment fund whose terms and investments conditions aligned with the Israeli Tax Authority "ITA") policies (in accordance with the provisions of the Ordinance and the ITA circulars that address  this).

The current situation, according to which the approval of the ITA is required and the fact that the ITA`s policies are expressed through administrative instructions rather than legislation, creates uncertainty for investors and investment funds.
In light of this, amendments are proposed with the aim, as mentioned, of providing certainty to investors and encouraging investments in Israel, including:

• It is proposed that, in certain situations, a partner's share of the partnership's income will be classified as income from a passive source or as capital gain, similar to how the income would be treated if generated outside the partnership, even if the partnership's income is classified as business income. It is proposed that this change will apply to both foreign and Israeli residents, and to both limited partnership and unlimited partnership.
•  It is proposed to provide a tax exemption or relief to a foreign resident investor on income generated from investment in investment funds, as well as an exemption for capital gains, even if the capital gain arises from a permanent establishment in Israel.
• It is proposed to set the tax rate for success fees earned by a managing partner resident in Israel from the fund`s profits at 32%, in contrast to the current position of ITA, which treat this as business income.
• Regarding VAT, it is proposed that the management fees received for investments made by non-residents in investment funds be subject to a zero VAT rate, specifically for the portion of the management fees attributed to their share in the partnership. Regarding success fees generated by the managing partner, the proposed benefit is that under certain circumstances, an exemption from VAT will apply.
   

We would like to remind you that at this stage it is only a memorandum of law that is required to go through a legislative process before it becomes binding, and we will of course continue to update you with the progress of the legislative process and its results