Israel turns to tax breaks to lure back foreign high-tech investors
Israel turns to tax breaks to lure back foreign high-tech investors
As investments drop, the government plans to roll out new tax incentives to reinvigorate foreign interest.
Contrary to the statements made by Finance Minister Bezalel Smotrich at the press conference for the launch of the 2025 state budget, the real data on the high-tech industry presents a bleak picture.
Just last week, IVC, one of the leading data sources and business information companies in the local industry, published preliminary estimates for the third quarter of 2024. According to these figures, Israeli high-tech companies raised only $938 million across 61 transactions (though the quarter is not yet complete, and the numbers may be updated). This is the lowest amount of capital raised in seven years, since Q3 2017, and the lowest number of transactions in the last decade.
Even compared to recent quarters, including those following the October 7 disaster, the figures are concerning: a 70% decrease compared to the previous quarter and over 51% compared to Q1 2024. Regarding the number of transactions, the decline is even steeper: 58% compared to the previous quarter and one-third compared to Q4 2023. This indicates that the downward trend that began three years ago is only worsening.
These figures aren't just a quarterly anomaly. From an annual perspective (January-August 2024), Israeli technology companies raised $5.9 billion compared to $6.7 billion in the same period last year, a 12% decrease. The number of transactions also dropped significantly, from 666 in 2023 to 386 in 2024, marking a 42% decline. Additionally, the revenue index for the information and communication sector, as measured by the Central Bureau of Statistics, decreased by around 10% from the beginning of the year through June.
The Ministry of Finance and the Israel Innovation Authority are fully aware of these figures and the prevailing mood in the industry. They did not buy into the optimistic outlook that the Finance Minister attempted to present. For several months, a team from the Ministry of Finance—which includes the Tax Authority, the Chief Economist, the Budget Division, and the Innovation Authority—has been working alongside senior high-tech industry leaders to formulate strategies to encourage investment in high-tech, a sector that has long been a key driver of the Israeli economy and is expected to be crucial for renewed growth after the war.
Calcalist has learned that the team has focused its efforts on one critical aspect for the high-tech industry: taxation. The consensus is that encouraging investments in the sector hinges on providing greater tax certainty and making Israel’s tax regime more attractive to investors.
The first significant proposed change relates to capital gains tax for foreign investors. While many countries offer foreign investors exemptions from capital gains tax, in Israel, the exemption is conditional upon the investor not having a "permanent establishment" in the country. The lack of clarity surrounding the definition and conditions of a "permanent establishment" creates uncertainty for investors and exposes them to potential tax assessments. Although investors can engage in a preliminary process with the Tax Authority (pre-ruling), this does not guarantee that an exemption will be granted. As a result, various types of investors—pension funds, family offices, high-net-worth individuals, and international corporations (Limited Partners)—often avoid investing due to the uncertainty and exposure to tax assessments.
The legislative change currently being considered aims to provide more certainty in this area, thereby encouraging foreign investment in Israel. Data over the past two years shows a decline in foreign investments, and the ambiguity surrounding taxation has become a deterrent for many investors.
The second proposal concerns the taxation of multinational companies operating in Israel, particularly regarding the tax base. This is a complex and sensitive issue for major companies such as Microsoft, Google, and Meta (Facebook). According to a report by the Chief Economist, although only 7.6% of high-tech companies in Israel are multinational, they provide about a quarter of the jobs in the industry, pay employees 35% more than local high-tech companies, and their employees’ average monthly income tax payments are 67% higher.
The issue of corporate tax for these global companies often sparks controversy, with critics arguing that they do not pay "real tax" based on their activities in Israel. Currently, these companies are taxed using the "Cost Plus" model (as opposed to the "Profit Split" method). Under the "Cost Plus" model, expenses are taxed along with a small margin (the "Plus").
Technology giants operate in Israel through subsidiaries, raising the question of whether these subsidiaries are subcontractors providing services to the parent companies (e.g., as R&D centers) or independent production units subject to full taxation. Currently, there is no clear guidance for companies regarding the pricing method they will be taxed under, and they must undergo a lengthy "pre-ruling" process with the Tax Authority. The conclusion reached by the team is that for Israel to remain competitive, it must create certainty regarding this issue. The proposed solution is to establish a "green track" for taxation based on self-reporting.
The team's reasoning is that when multinational companies decide where to place their next project, internal competition occurs between different branches around the world. Taxation and regulatory certainty are major factors in these decisions. Given the complex challenges Israeli branches are currently facing due to the war, such certainty is critical for Israel to be chosen as a preferred investment location.
The third proposed reform relates to the taxation of mergers involving share exchanges. Currently, tax benefits apply if the value of the acquiring company is more than nine times that of the target company, allowing the buyer to defer taxes until the shares are eventually sold. The recommendation is to increase this ratio to 20 times, thereby facilitating mergers in light of declining company valuations, particularly among smaller companies seeking buyers.
This change would expand the number of companies eligible for tax exemptions during mergers. A significant impact of this measure would be the consolidation of large and small companies in Israeli high-tech, creating stronger and more competitive firms while preventing the closure of smaller startups.
Meanwhile, measures promoted by the Ministry of Finance and the Innovation Authority in the 2024 budget have been initiated but not fully implemented. For instance, a call was recently issued aimed at bringing back 131 star scientists—56 senior scientists with proven track records and 75 young faculty members—from abroad. The program, with a total budget of NIS 734 million, is set to fully mature over 5 to 7 years.
An interesting innovation in this program is that part of the funds is directly earmarked for the researchers, while the majority still goes towards grants and the establishment of laboratories. The National Science Foundation, headed by Prof. Daniel Zajfman, former president of the Weizmann Institute, is executing the program. Calcalist has learned that private entities have expressed interest in contributing to the various programs since the call was published.
The issue of brain drain from Israel—first due to the attempted judicial overhaul and later exacerbated by the war—has become critical to the economy, especially the high-tech industry. Despite public denials, Treasury officials are well aware of this phenomenon.
The Yozma 2.0 fund has also been launched. This new Innovation Authority fund, working with institutional investors, is designed to increase the availability of capital for the high-tech venture capital industry. Unlike previous funds, which offered downside protection for losses, this fund focuses on upside potential: the government matches institutional investments (which are extremely low compared to global norms), contributing 15-30 cents for every dollar invested without diluting the institutions' holdings.
The key advantage is that institutional investors earn a return on capital that is not theirs. Calcalist has learned that institutional bids for the program exceeded Treasury expectations by threefold. Current estimates suggest the program will inject approximately $1 billion into the venture capital industry, particularly benefitting early-stage tech companies that are currently struggling to attract investment. Institutions are expected to invest this capital over the next 18 months.
The third initiative is the "Start-Up Fund," designed to invest in startups in deep-tech fields, which typically require laboratory facilities, hardware, and face heavy regulatory burdens. These companies often experience significant market failures and, unlike software companies, have less predictable time-to-market timelines.
The idea is for the state, through the Innovation Authority, to co-invest in early-stage rounds alongside private investors, with grants remaining non-dilutive and lowering the risk for participating investors. "There’s no such thing as 'grants against expenses' anymore, the condition is now trust from the private market," a source familiar with the program explained to Calcalist.
