A Supportive Tax and Funding Environment for Innovation

For high-tech innovation in Israel, the country has created a great tax and financing environment for startups. With reduced corporate tax rates, generous R&D incentives and tax credits for both founders and investors, high-tech startups can get relatively lower corporate tax rates than other businesses with the same income levels are able to pay.

In general, a qualified tech startup will usually pay corporate taxes at a much lower than the standard rate of 23%.

However, as an example, a “Preferred Technological Enterprise” under the Encouragement of Capital Investments law will typically pay a corporate tax ranging from 6% to 12% on qualifying income.

These unique tax incentives will place Israel’s tax rates among the most attractive in the world for high-tech firms.

R&D Grants and Tax Credits Through the Israel Innovation Authority

Additionally, there are numerous opportunities for startups to also access large amounts of government grants and tax credits for their R&D costs through the Israel Innovation Authority (IIA).

As such, the IIA has an R&D Fund that provides grants to cover 20% to 50% of a qualifying startup’s R&D costs, and even up to 75% for early-stage minority or underrepresented entrepreneurs.

Therefore, these grant funds will result in a reduction in the amount of taxable expenses a qualifying company is responsible for paying taxes on.

Similarly, qualifying companies will also be able to take R&D tax credits, which will enable them to either deduct their qualified research expenses from their revenue for tax purposes or have a tax credit for the research expenses as well (Israel Tax Authority – R&D Deductions Guidance).

For example, all the qualifying equipment used in qualifying R&D projects will receive expedited depreciation over five years, thereby enabling the company to deduct their cost of the equipment for tax purposes at an accelerated rate.

As such, the combination of the R&D Fund and R&D tax credits will allow qualifying startups to extend their budgets by decreasing their taxable income and/or receiving financial support from the government to finance their innovation activities.

The “Angels Law” and Investor Tax Incentives

In addition to creating a general encouraging tax climate for all startups in Israel, the Israeli government has enacted new tax legislation that enhance the benefits for companies, particularly in the “knowledge industries”.

The “Angels Law” encourages investors to make investments in new startups by providing them tax benefits for such investments.

For instance, an investor may receive a 33% tax credit on their investment in an Israeli startup.

Angel investors who reinvest any capital gains from the sale of their investment in a new Israeli startup within a prescribed period will be able to defer their capital gains tax or be exempt from capital gains tax on the reinvested proceeds.

Tax Exemption on Overseas Loan Interest

For “foreign loans” received and the interest paid on them, companies may deduct the interest expense for taxable purposes, thus making all “foreign” loans considerably cheaper and more appealing to startups raising funds from foreign sources.

Corporations who own high-tech companies and are looking to acquire more technology companies can use the purchase price of the other company as a deduction from their “preferred” income through a tax return, which reduces the taxes owed. This incentivises technology startups to raise capital and develop in Israel as opposed to other countries.

Development Zone and SPTE Incentives

Other forms of Corporate Tax Incentives would include Development Zone Incentives. These include additional monetary assistance for R&D projects in Development Zones or near Gaza.

It is common for a company to have developed R&D and Intellectual Property in a Development Zone and enjoy lower tax rates than if developed in a non-development zone.

For example, under Israeli law, if a company has “Special Preferred Technological Enterprise” (SPTE) Status, then qualifying income would be taxed at only 6% even though generated from outside of Israel, whereas other income would be taxed at 23%.

With respect to sales and profits from innovative products, a startup that qualified for SPTE status can significantly reduce the taxes it pays.

Summary of Key Startup Tax Benefits

• R&D Tax Credit: An R&D Tax Credit can give the startup funding for at least up to 50% of R&D expenses as well as a deduction/credit for other qualifying R&D expenses.

• Reduced Corporate Tax: High-tech companies with accepted R&D projects will most likely become “Preferred Technological Enterprises” and pay taxes on income between 6% and 12% instead of 23%.

• Angel Investor Tax Credits: An angel investor who subscribes or invests capital into a qualified Israeli start-up company will receive tax credits (portion) of their investment which can be claimed against their personal taxes.

• Capital Gains Rollover: A shareholder can defer any capital gains tax by selling their shares in a technology company and using those proceeds to invest in another Israeli technology startup within the next 12 months.

• Foreign Loan Deduction: Israeli technology companies can deduct the interest on loans from foreign banks when calculating their taxable income in Israel.

• Accelerated Depreciation: Startups that are approved for grants from the Innovation Authority may depreciate their research and development (R&D) assets over a five-year period instead of the traditional useful life of 20 years.

Why These Incentives Matter

These incentives are why Israeli founded startups pay much lower tax rates on R&D expenses and profits than traditional businesses. In addition to lowering their effective tax rate, the Israeli government provides startup businesses that perform R&D with early stage cash incentives, encouraging them to form and remain in Israel and to build a stronger startup community where the founders can continue to retain cash to reinvest in their business and investors can expect to receive higher after-tax returns on their investments.

Practical Examples

A software qualifying startup can receive a 6% tax rate on IP driven revenues as a preferred technological business/enterprise. Further, if the startup received 30% of its R&D cost from funding through the Innovation Authority, both its future tax and cash requirements would be reduced as well.

An angel investor who invests ₪100,000 in a seed-stage startup in Israel will therefore have a reduction of approximately ₪33,000 against their obligation to pay Israeli tax creating a more attractive fundraising environment.

Conclusion

In closing, the Government of Israel is committed to fostering innovation through the establishment of local companies. The tax, R&D grant, and investment incentives system in Israel creates a competitive environment for start-ups and provides them with a significantly higher level of funding than most foreign countries. Therefore, start-up founders and teams can concentrate their efforts on developing new technologies, while being confident in knowing that the current tax system will support, rather than hinder, their growth.

FAQ

What services are provided by ERB to Israeli-based start-ups?

ERB provides 100% financial support for start-ups located in Israel. Our key services include outsourced CFO services, accounting, payroll, tax compliance, corporate set up and other professional services. ERB tailors its services throughout the startup life cycle.

In what ways can ERB help start-ups take advantage of Israel’s tax incentives?

ERB’s tax experts educate startups regarding Israeli tax law, help apply for R&D grants, structure tax-efficient entities and maximize available credits such as Angels Law incentives while ensuring full compliance.

Will ERB assist foreign entrepreneurs to set up a business entity in Israel?

Yes. ERB assists with company registration, liaison with tax authorities and onboarding functions, ensuring the Israeli entity is fully operational and optimized for local tax benefits.

How will ERB assist high-tech companies maintain compliance?

ERB assists with corporate tax returns, VAT compliance, payroll, Section 102 stock option plans and deductible expense reimbursements. The objective is to minimize tax risk and maximize lawful benefits.