The Israeli Tax Authority has just issued a tax circular with the innocuous title “Allocation of Income To R&D Centers” (Circular 8/2025 of November 2, 2025).
This circular is not a little acorn; it is a mighty oak. The proverb “Mighty oaks from little acorns grow” is said to emanate from the poem “Troilus and Criseyde” by Geoffrey Chaucer in the late 14th century.
In 2025 to date, Israeli tech M&A (merger and acquisition) deals total around $60 billion! Google acquired Wiz for $32b., Palo Alto Networks acquired CyberArk for $25b., and there were other deals of just a few billion dollars.
Israel collects immediate capital gains tax from Israeli resident sellers at rates of 25%-35%. This helps finance the war.
When do the R&D centers factor into such M&A deals? Sometimes before, sometimes after the deal.
Why? Partly for tax reasons.
Tax reasons
There are two main ways of structuring an M&A deal – asset acquisition or share acquisition. Large multinational buyers typically prefer to buy assets (especially intellectual property, IP) and park them offshore. But if the sellers have something the buyer needs, they may insist on a share sale to reduce the tax on their exit.
If the buyer buys the shares of the Israeli target company, then makes the company transfer the IP to an offshore country, the ITA taxes both the share sale and the IP transfer, and possibly a deemed in-kind dividend i.e. double or triple tax that could approximate over 80%.
There have been numerous Israeli court cases about this massive tax hit. In many cases the ITA won, but not where the IP transfer was part of a legitimate business model change.
Potential multiple tax solution
A business model change – switching to an R&D center providing R&D services to develop IP transferred instead of using it to sell something.
The ITA R&D center circular
The ITA circular spells the ground rules for a business model change in 2025-2029. The following is a very brief overview.
Eligibility conditions
The circular apparently isn’t available to everyone. The circular is reserved for acquiring groups with global revenues over NIS 10b. where the parent company is a resident in a country that has a tax treaty or an information exchange agreement with Israel. Israeli residents and people who left Israel in the last 10 years should hold under 10% of the acquirer. The acquirer group must hold no more than 50% control before the M&A deal but 100% control after the deal.
The acquired company must meet the conditions for a special preferred technological enterprise that derives technological income, according to detailed definitions in the Encouragement of Capital Investments Law.
Conformation of this at the time of closing the M&A deal is needed from the Israel Innovation Authority.
Other conditions
First, the IP transfer and R&D center formation must take place within 180 days after closing the M&A share acquisition deal but with effect from the closing date. All IP must be transferred. The R&D center must stay in business until December 31 of the seventh tax year after the M&A share deal closes.
Second, the IP transfer should be conducted at a price equating to at least 85% of the price paid for the shares according to a formula (85% minus cash plus liabilities). No sudden drastic write-downs.
Third, the resulting gain on the IP transfer may be taxed at only 6% in the case of a special preferred technological enterprise
Fourth, the R&D services provided by the R&D center may be billed out at cost plus up to 14% (applying the Transaction Net Margin Method), although other transfer pricing methods may be acceptable. A transfer pricing study is required that specifies many thing,s including “comparables” included in or excluded from the study. No rigging the sample used.
Fifth, a tax ruling should be obtained. The ITA circular specifies the applicable principles. The circular notes that the law lays down deadlines (180-300 days) for the ITA to decide on transfer pricing ruling requests. If there is no reply in time, the transfer ruling request is deemed to be accepted. If the taxpayer prefers a bilateral or multilateral Advance Pricing Agreement in all countries concerned, the above time limits won’t apply.
Sixth, a local tax office apparently cannot decide on its own to tax a change of business model, without approval at the national level from designated officials at the ITA’s Professional Division.
Comment
The ITA circular may prove invaluable to multinational groups making acquisitions in the Start-Up Nation.
As always, consult experienced advisers in each country at an early stage in specific cases.
The writer is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.