Hedge Funds in Israel: Structure, Taxation, and Regulatory Considerations

July 11, 2023

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Funds of hedge

Unlike other financial instruments such as mutual funds, hedge funds are not limited in their investment methods and are not subject to much regulation. Hedge funds can invest in stocks, commodities, currencies, or any other asset, making them an alternative investment to traditional financial instruments. As a result, the vast majority of hedge funds are registered in offshore jurisdictions, which offer a more favorable tax regime and regulatory environment.

This article focuses on Israeli hedge funds and examines the tax implications of such funds.

Structure of the fund and its actors

In most cases, the founders of a hedge fund choose to register it as a limited partnership consisting of a general partner (the fund's management company owned by the fund's founders) and limited partners (the fund's investors). In addition, in Israel (unlike in other countries), there is also a requirement to appoint a trustee for the fund. This is because a hedge fund is a private, non-regulated entity with a great deal of independence, and therefore the state, through the trustee, wants there to be a supervisory body overseeing the fund's activities towards the limited partners and the state.

General partner: The general partner is the one who sets the fund's investment policy and is responsible for all of the partnership's obligations. In return for his services, the general partner receives a fee in the form of management fees, which are generally composed of two components. One is a success fee (a percentage of the fund's return) and the other is a percentage of the total assets under management.
Limited partner: This partner, as its name suggests, is responsible for the partnership's obligations up to the amount of his investment in the fund. A limited partner can be an individual or a company, but in any case he must be a "qualified investor" as defined in the first supplement to the Securities Law.
Trustee/tax trustee: As we mentioned, the trustee's role is twofold. On the one hand, he is responsible for calculating the fund's returns and profits reported to the limited partners, and it should be noted that the general partner requires the trustee's approval for any action in the fund's account (except for any matter related to investment). On the other hand, the trustee is responsible for calculating taxes and paying them to the tax authority.

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‍Tax regime applicable to hedge funds

Unlike other cases, when it comes to hedge funds, there is a need to obtain a Pre Ruling (tax ruling) in advance from the tax authority. The need for a tax ruling stems from the desire to provide the limited partners with certainty in relation to their share in the fund.

Before addressing the possible tax arrangements for the taxation of hedge funds in Israel, we will highlight a number of principles that apply in the various arrangements:

Principle 1: The fund's activity itself will not constitute business income for the limited partners.
Principle 2: The general partner must register as a "financial institution" (as defined in the Value Added Tax Law) in relation to the share of Israeli limited partners in the fund.
Principle 3: The general partner's income will be classified as income from a business that was produced and grown in Israel.
Basic 4: Where a foreign limited partner is involved, the hedge fund will be exempt from withholding tax on income that, if received directly by a non-resident, would be exempt from tax. For non-exempt income, the fund must withhold tax at a rate of 25%, subject to the relevant tax treaty.
Basic 5: The income from an investment in a hedge fund of an Israeli limited partner will be taxed at a tax rate ranging from 25% to 30% (depending on the circumstances).

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First tax arrangement - exempt hedge fund

When a hedge fund chooses to be an exempt fund, it is in fact a transparent body for tax purposes, so that the fund's income from its activity is taxed by the limited partners (each in relation to his share in the fund) and not by the fund itself.

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Second tax arrangement - taxable hedge fund

When a hedge fund chooses to be a taxable hedge fund, it is the one that is taxed on the income from the fund's activity and the limited partners are exempt from tax on the income that reaches them.

Pursuant to the decisions of the Securities Market Division of the tax authority, there are a number of additional distinctions that differentiate between the various arrangements, the main ones relate to the time of the tax event, the time of payment, the obligation to withhold tax at source and the mechanism for offsetting losses. In fact, entrepreneurs in the field of the capital market who wish to establish an Israeli hedge fund should consider which of the various

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