The Israeli Finance Ministry published its draft economic program (i.e. budget) for 2025 on October 14, 2024. This contains a series of decisions and explanations but no clauses yet for the draft 2025 budget law. The credit rating agencies have complained about delays in the 2025 budget process. They do not appreciate the Israeli penchant for getting things done at the last minute.

Following is an overview of the draft 2025 economic program. We have left in page numbers in case there are questions or comments. The public has until 2pm on October 28 to submit comments to: [email protected].

POLITICAL

IDF:

It is proposed to make the IDF payments and salary systems subservient to a Controller appointed by the Finance Ministry, instead of the Defense Minister (Pg.32). Comment: Non-starter.

Abandoned property:

It is proposed to enable abandoned property to pass to the government without Court approval (Pg.36). Comment: Back-door legal reform. Reduces checks and balances.

Police recruitment:

It is proposed to allow the Finance Minister and National Security Minister (Smotrich and Ben Gvir) to hire Police on special personal employment contracts. Comment: Ditto.

PERSONAL

National Insurance Contributions:

It is proposed to raise national insurance contributions on passive income by 10% and to make employees and freelancers pay at least the same national insurance. The maximum income for lower rate limit national contributions will be updated according to inflation instead of average earnings. The Finance Ministry will peg the extent of its support for pensions paid by the National Insurance Institute starting in 2025, which may create issues as the population ages (Page 26). Expected revenues NIS 0.7 bn in 2025, NIS 2.13 bn in 2026 (pg.26).

Tax and national insurance payment systems are to be combined.

Tax on Passive Income and Gains:

A 2% additional surtax is proposed if total passive income and gains exceed NIS 721,560 per year. The result could be tax of up to 30%-35% on dividends, interest and capital gains/land appreciation and up to  52% on rental income.

New Immigrants (Olim):

The “absorption basket” (Sal Klita) paid to Olim for 6 months will be subject to a means test (Capital Declaration / Hatsharat Hon) from 2025 and denied if the Oleh has assets over NIS 500,000 (Pg.30). Comment: The bureaucracy is likely to deter Aliya. Potential Olim will find it less bureaucratic migrating to other countries. Young aspiring techies won’t know how to their value stock options in tech start-ups.

Study Funds:

It is proposed to tax interest and other profits from study funds (Kranot Hishtalmut) from January 2025. Comment: This proposal would affect the 6 year savings plans of many employees and freelancers (Pg.208). It would be unpopular and we doubt it will be enacted.

Pensions:

It is proposed to reduce tax free pension and severance pay contributions by employers from 3.3 times to twice the national average salary (Pg. 210).

Foreign Workers:

It is proposed to abolish tax credits for foreign workers. Comment: Israeli agriculture, health care and other sectors employ many foreign workers. Some were even taken hostage in Gaza on October 7  (Pg.170).

BUSINESS-RELATED

Undistributed Corporate Profits:

The Economic Program reiterates earlier published proposals to tax undistributed profits of, apparently,  private companies. The aim is to collect tax approaching 52%, not just 23% company tax. This may be achieved in several ways: tax shareholders on deemed dividends, tax and national insurance on deemed salary and/or 2% surtax on undistributed passive profits. Assuming the proposals are enacted, pre-enactment undistributed profits would also be retroactively caught. Consequently, the Economic Program estimates tax revenues from this measure at NIS 10bn in 2025 and NIS 4-5bn per year after 2025.  There may be transitional rules allowing actual dividends to be paid and taxed anyway.

Comment: Not good. The government expects to raise NIS 5-10bn per year by taxing undistributed profits, but the public has only two weeks spanning the Succot holiday to react. The above proposals are drafted in a short vague fashion. The government knows the tax would be retroactive (Pg.184). Employees may be fired to pay the tax. Reinvestment in Israeli business is discouraged. The use of foreign companies to do business in Israel and abroad is encouraged. Foreign investors seem likely to face double taxation – they cannot credit Israeli tax now on a hypothetical dividend against future capital gains tax in their home country.

What are the alternatives?  (1) Past wars have been financed by war loans to the government, not retroactive taxation, e.g. Peace For Galilee Loans used to finance the first Lebanon War. (2) The Israeli CPA Institute suggested reduced tax rates for dividends for a period, the Israeli government rejected this for not being a permanent solution. (3) Many other countries are already applying OECD digital taxation recommendations for taxing multinationals at 15%, especially on offshore profits while allowing onshore R&D tax credits, Israel might start this in 2026.

Venture Capital Funds:

Venture capital (VC) funds are the lifeblood of Israeli hitech. Hitech accounts for 20% of Israeli output, 53% of its exports and 36% of its tax on salaries. R&D totaled NIS 88bn spending represented 5.6% of GDP in 2021, the highest in the OECD (which Israel joined in 2010). Currently, each VC fund has to obtain an upfront tax ruling from the Israeli Tax Authority.  Usually, VC Funds are organized as limited partnerships – the investors are limited partners, the managers are general partners,

Now it is proposed to clarify when a partner derives passive not active income. This should help clarify upon an exit (sale) that: (1) Foreign investors are exempt from Israeli capital gains tax upon an exit (sale), and (2) Israeli investors are taxed at reduced rates (25%-35%). Furthermore, it is proposed to tax Israeli resident managers at a rate of 32% on their carried interest (“Carry” i.e. on success fees) – typically 20% of any capital gain.  In addition, it is proposed to impose 0% VAT on management fees relating to foreign investors, and to exempt the carried interest from VAT as it relates to a “financial asset” i.e. the shares in the Israeli tech company(ies) (Pg.189).

Comments:  No mention is made of taxing carry and other income of foreign VC managers, presumably because their services are outside the Israeli tax net if performed abroad.

R&D centers:

According to the Economic Program, in 2024 around 515 international groups employ 90,000 people. Around 72% work on software and chips, 10% in life sciences and 8% in communications (we are not told what the last 10% work on). Now it is proposed to clarify their taxable profit per OECD transfer pricing rules in a Circular and an expedited tax ruling process (“Green Channel to be published within 60 days after the law for this is enacted. These would specify when a “cost plus” basis is acceptable as opposed to the “profit split method” since OECD rules are perceived to be uncertain in this regard (Pg.189).

Comment: The Israeli Tax Authority started the uncertainty, the OECD transfer pricing guidelines are quite comprehensive in our view.

Mergers:

Technical adjustments are proposed to the tax deferral rules for mergers: one company can be up to 19 times larger than the other instead of ten times; limits on subsequent fundraising may be relaxed (Pg.189). Comment: We are skeptical this will do anything for hitech.

VAT Consolidated Group Returns:

It is proposed to abolish them as they make it harder for income tax enforcement – comparing reported sales, etc. (Pg.42).

Banks:

It is proposed to appoint an inter-ministerial committee to look into the possibility of a windfall profit tax in 2026. Comment: Israeli banks already pay a 17% Wage & Profit Tax as well as Company Tax (23%). Also, the banks have to provide for bad debts due to the war.

MISCELLANEOUS

Reducing the Black Economy:

It is proposed to outlaw cash payments totaling over NIS 200,000 per year, in addition to the present cap of NIS 6,000 cash on individual transactions.

Purchase tax on green cars:

It is proposed to raise purchase tax on less polluting cars by NIS 2,455 to NIS 7,500 to reverse earlier tax reductions on such cars (Pg 119).

Inflationary Updates to Tax Limits:

It is proposed to freeze them.

Tobacco:

It is proposed to halve the exemptions for taxes on personal tobacco imports on June 1, 2026 and repeal them by June 1, 2028 (Pg.15)

It is proposed to freeze indexation for inflation regarding minimum wages, office holders, pensions and social security (Pg.17).

Public Sector Employment:

The Finance Ministry intends to reduce public sector employment costs by at least NIS 3 billion per year in the years 2025-2028 by agreement with the Histadrut labor federation, by postponing pay increases or by reducing the relevant budget (Pg 205).

Next Steps:

Please contact us to discuss any of the above matters further, or any other matter.

As always, consult experienced legal and tax advisors in each country at an early stage in specific cases.

[email protected]

(c) Leon Harris 18.10.2024