Two consequences follow. First, the partnership is not itself the income tax taxpayer and is not assessed as one. The partners are taxed, each reporting its share in its own return and attaching the declaratory partnership appendix, Form 1504. The partnership does not file an annual return of its own. Under Section 63(a)(2), a return on the partnership's income is drawn up and delivered by the head partner only at the assessing officer's demand. Second, the term partnership is not defined in the Ordinance. Its existence is a question of fact, and a partnership can be found even where it was never registered.
A note on terminology: two Ordinances, two Section 61s, two Section 63s
This is the single most important precision point in the field, and the most common source of error. Two different statutes govern, and the same section numbers mean different things in each.
In the Income Tax Ordinance, Section 63 is the partnership transparency rule, and Section 61 is the cooperative agricultural moshav regime, which has nothing to do with partnerships.
In the Partnerships Ordinance, Section 61 is the constitution of a limited partnership, and Section 63 is the status of a limited partner.
So a reference to partnership transparency means Income Tax Ordinance Section 63. A reference to the formation of a limited partnership means Partnerships Ordinance Section 61. Every citation in this guide names its Ordinance for that reason.
Selling a partnership interest: the Sdot ruling
When a partner sells its stake, what exactly is being sold. The Supreme Court answered this in Sdot, שדות חברה להובלה, CA 2026/92, decided in 2001. By a majority of three to two, the Court held that the asset disposed of is the right in the partnership as a single capital asset, analogous to a share in a company, and not a proportionate sale of each underlying partnership asset.
The reasoning was that Section 63 governs only the taxation of partnership income, and cannot be stretched to other questions such as the sale of the interest. The selling partner is therefore taxed under the capital gains rules in Part E of the Ordinance, as if selling a share.
The Tax Authority calls the resulting regime the mixed approach. The separate entity view governs the sale of the interest and transactions between a partner and the partnership, while the look-through view of Section 63 governs the partnership's current operating income and gains. The ruling is operative law and the express basis of the Authority's binding circular, but two points are worth noting. It was a divided three to two decision, and academic writing argues that this judge-made regime remains an incomplete substitute for legislation.
Computing the gain: the cost of the right
The mechanics of the gain on a sale appear in Income Tax Circular 14/2003. The partner's cost of the right is built up over the life of the holding. It begins with contributions to the partnership, in cash or assets at value, and is then increased by the partner's share of taxed partnership profits that have not yet been distributed, and reduced by drawings and by the partner's share of partnership losses for tax over the same period.
The design goal is to prevent both double taxation, for example of profits that were taxed but not distributed, and double benefit, for example of losses already allocated. As a concession beyond the strict letter of the law, the inflationary component may be computed by reference to the partner's own investment and drawing dates rather than re-deriving each underlying asset.
Contributions in, distributions out, and liquidation
Three further events are commonly under-appreciated, and under Circular 14/2003 each is a realization event.
A contribution of an asset by a partner to the partnership is a realization event. The deemed consideration is the asset's fair market value at transfer, taxed under Part E. It is not a tax-free roll-in under the circular's default rule.
A distribution of an asset from the partnership to a partner is also a realization event, treated as a sale of the asset by the partnership, analogous to a company distributing an asset to its shareholders, with the gain allocated among the partners by profit share.
On dissolution and liquidation, Section 93 applies. Gains are computed at the partnership level and allocated to the partners. Assets not sold within two years of liquidation are deemed sold, and on the liquidation start date each partner is treated as selling its interest for the assets received, with a credit mechanism to prevent double tax. Transactions between a partner and the partnership are respected when they are at arm's length with genuine substance, and disregarded when tax-motivated.
Note the circular's own limits. It does not apply to limited partnerships for films or oil, nor where the Real Estate Taxation Law applies, so the scope should be confirmed for any real estate heavy partnership.
Cost basis and allocation among partners
Each partner's basis is tracked individually. It rises with contributions and with taxed but undistributed profit shares, and falls with drawings and allocated losses, following the build-up above. Allocation among partners, of income, of partnership-level capital gains on a distribution, and on liquidation, follows the partner's share in the partnership's profits, the same key used to attribute operating income under Section 63.
The cross-border layer
This is where the transparency model meets foreign systems, and where most of the real complexity sits. A reform proposed in 2021, discussed at the end, would rewrite much of what follows. The treatment below is the current law.
A foreign partner in an Israeli partnership
Because the partnership is transparent, a foreign partner is generally taxed in Israel on its share of the partnership's Israeli-source income, which keeps its character and source. If the partnership carries on business in Israel, that activity can constitute a permanent establishment attributed to the foreign partner, creating substantive Israeli liability and a filing footprint. A treaty-resident partner is taxable on Israeli business profits only where there is a permanent establishment in Israel. Domestic withholding on income remitted abroad applies unless reduced by a treaty or by a Tax Authority certificate.
An Israeli partner in a foreign transparent entity, and the US LLC mismatch
If the foreign vehicle is respected as transparent in Israel, the Israeli partner is taxed currently on its share. The recurring hard case is the US LLC. It is transparent in the United States, but Israel classifies it as an opaque body of persons under the Section 1 definition. Absent relief, an Israeli member who pays US tax on attributed income would get no Israeli credit, because Israel sees no income until a later distribution, by which point no US tax is withheld.
Income Tax Circular 5/2004 resolves this. It lets the Israeli holder elect to report the LLC's income currently and personally, and to take a credit for the US tax under Sections 199 to 210, with no further Israeli tax on the later distribution. The election is irrevocable. The circular also coordinates the controlled foreign company rules and the foreign professional company rules, and does not change the entity's classification. The question has also been litigated at the District Court level.
Entity classification and hybrid mismatches
Israel classifies a foreign entity by its own domestic-law characteristics, independent of the foreign label, and there is no statutory check-the-box code. Classification turns on the body of persons definition in Section 1 and on the Tax Authority circulars. A US LLC that is transparent abroad is therefore opaque in Israel, the textbook hybrid mismatch. Direction matters. Where the entity is opaque in Israel and transparent abroad, the LLC case, the fix is the credit and timing election of Circular 5/2004. Where the entity is transparent in Israel and opaque abroad, the matter is handled at the partner level through Section 63 and the treaties. There is no single bright-line statutory rule, so certainty should not be overstated.
Treaty characterization: is a partnership a person, and a resident
The OECD framework is set by the 1999 Partnership Report. Its core principle is that where a state treats a partnership as transparent, the partnership is not liable to tax and so is not a resident, treaty benefits are claimed by the partners in their residence states, and the source state should respect the residence state's transparency characterization.
The treaty between the United States and Israel is the clean worked example. Its definitions article includes a partnership within the meaning of a person. It then makes a partnership a resident only to the extent that the income it derives is, in the treaty's words, subject to tax as the income of a resident, whether in the hands of the entity or of its partners. In other words, a partnership is a treaty person, but it qualifies as a treaty resident only to the extent its income is actually taxed as a resident's income, so treaty access flows to the partners. Modern Israeli treaties reinforce the pattern by denying the reduced direct-dividend rate where the beneficial owner is a company other than a partnership, and Israel has adopted the Multilateral Instrument.
One caution. There appears to be no Israeli circular or ruling that expressly adopts or rejects the 1999 Report, so Israel's position is inferred from treaty text and practice rather than from a formal domestic adoption.
Withholding on distributions to a foreign partner
Domestic withholding on Israeli-source income remitted abroad is generally taken at the corporate tax rate, with higher brackets where relevant, for example for a substantial shareholder, unless reduced by a treaty rate or a Tax Authority certificate. A reduced treaty rate can be denied for income connected to a permanent establishment, and is subject to beneficial-ownership and Multilateral Instrument conditions.
Investment funds: the venture capital and private equity regimes
Venture capital and private equity funds operate under a special advance arrangement under Section 16A, set out in Income Tax Circulars 9/2018 and 10/2018. A narrower statutory hook already exists in the Ordinance itself. Section 63(e) lets the Director direct, for certain limited partnerships with business income, that a limited partner's taxable income be treated as a capital gain under Part E for a period of up to 183 days. It is an existing statutory instance of the same business-to-capital-gain recharacterization that the fund practice turns on.
For venture capital funds, the arrangement rests on cumulative conditions, among them a minimum number of unrelated investors, caps on any single investor's share, a minimum proportion of foreign investors, minimum commitments including a foreign minimum, qualifying Israeli technology investments, and separation of the general partner from the limited partners. Under the arrangement the fund, the foreign investors, and the general partner in respect of foreign right-holders are exempt on venture capital investment income, while the manager operates through a fixed place of business in Israel and is fully taxable, and foreign right-holders in the general partner are taxed at 15% on carried interest.
For private equity funds, a parallel arrangement applies. Foreign investors are exempt on realization gains, dividends to foreign individuals are taxed at 15%, qualifying foreign pension and public bodies from a treaty country are fully exempt on dividends and interest, the manager is taxable through a permanent establishment in Israel, and foreign general-partner carry is taxed at 15%.
Both regimes are current administrative practice under Section 16A, and both are scheduled for statutory replacement by the 2021 reform, which would confine standing advance arrangements to venture capital funds.
Limited partnerships and public limited partnerships
The Partnerships Ordinance governs the structure, in Part F and Part F1, and the section numbers here are Partnerships Ordinance sections.
A limited partner contributes capital on terms that cap liability at the amount contributed, while a general partner is any partner who is not limited. A limited partnership must have at least one general partner liable for all obligations and at least one limited partner, and a corporation may be a limited partner. Registration is required.
Section 61 is the constitution of a limited partnership. The partnership is established under a written agreement, a copy is filed with the Registrar, and the Registrar submits it to the Minister of Justice, who may permit or refuse registration at absolute discretion. The partnership may not commence business before it is notified of approval.
Section 63 of the Partnerships Ordinance, not to be confused with the income tax provision, is the status of a limited partner. A limited partner does not participate in management and cannot bind the partnership, may not withdraw capital during the partnership's life, and becomes liable as a general partner if it takes part in management.
Part F1, added in 2015, governs the public limited partnership, whose participation units are traded on the Tel Aviv Stock Exchange or offered by prospectus. The general partner must be a private company whose sole business is managing the partnership, the chapter imports company-style governance, and a statutory supervisor protects the unit-holders. This is the vehicle used for publicly traded oil and gas exploration and similar partnerships.
For tax, the distinction between a general and a limited partnership is a liability and company-law distinction, not a separate tax regime. Whether general or limited, a partnership is transparent under Income Tax Ordinance Section 63. The exception is an order made under Section 63(d) of the Income Tax Ordinance, which treats two categories as opaque and taxed as companies, namely Israeli-resident oil and gas exploration and production partnerships and Israeli-resident research and development partnerships, chiefly publicly traded ones. Current Tax Authority practice reflects this. A 2026 circular defines a transparent entity to include a Section 63 partnership and to exclude one to which Section 63(d) applies.
VAT: the partnership as a single dealer, and the VAT group
VAT does not follow income tax transparency. For VAT, a partnership registers as a single dealer in its own name, and a representative signs its returns.
A separate mechanism is the VAT group under Section 56 of the VAT Law. Israeli-resident dealers whose fixed and continuing place of business is in Israel may apply jointly, with the approval of the Director of VAT, to be treated for VAT purposes as partners. Eligible combinations include a company and its subsidiary, two subsidiaries of one parent, and a partnership together with a partner holding at least half of it. The core benefit is that internal transactions between members are disregarded, so no VAT invoice is raised on intra-group dealings. The trade-off is joint and several exposure for the group's debts and offences, and each member still issues invoices under its own dealer number with a legend noting that it reports for VAT within a group. A repeal of the VAT-group regime has been floated in past sessions but not enacted, and the current law should be confirmed before relying on it.
Rates and thresholds for 2026
Corporate tax is 23% under Section 126(a). A dividend to an individual is taxed at 25%, rising to 30% for a substantial shareholder of 10% or more, under Section 125B. A surtax of 3% applies under Section 121B to annual income above a threshold of 721,560 shekels, with that threshold frozen for the 2025 to 2027 years. From 2025, an additional 2% surtax applies to high passive and capital income such as interest, dividends, rent, and capital gains, bringing the top surtax to 5%. In practice a substantial-shareholder dividend above the surtax threshold can bear in the region of 35% in total.
A separate regime should not be conflated with the headline corporate rate. The 2025 rules on undistributed, or trapped, profits in closely held companies add distribution-incentive and surtax mechanisms of their own, and their specific rates should be taken from the operative amendment and the Tax Authority circular rather than assumed.
Form 6111 and the 300,000 shekel figure
Form 6111 is a mandatory annex to the annual return that codes the financial statements into a profit and loss part, a tax-adjustment part, and a balance sheet part. It does not replace audited financial statements. The return and its annexes flow from Section 131 of the Ordinance, and the prescribed format and mandatory online filing rest on Section 240B.
One point is often described backwards. The 300,000 shekel figure is a floor below which Form 6111 is not required, not a ceiling that triggers it. By a Tax Authority decision, an exemption is granted to companies and small businesses whose turnover is below 300,000 shekels. For a partnership, a partner reports the partnership's full financial-statement data, and a dedicated field carries the partner's pro-rata share of taxable income or loss into the partner's personal return.
The reform on the horizon
A comprehensive reform was proposed in the Memorandum for a Law to Amend the Income Tax Ordinance on Partnership Taxation, published in July 2021 for public comment. Among many changes, it would compute income at the partnership level, require the partnership to register with the assessing officer and file its own annual return with audited financial statements, impose registration and reporting on foreign partnerships with Israeli-source income or a majority of Israeli-resident partners, appoint a reporting partner who would withhold on distributions to foreign-resident partners, codify the Sdot capital-gains result, tax distributions above basis as capital gain, treat carried interest as business income, and replace the fund-ruling practice with legislation confined to venture capital funds. That the memorandum needs to create the partnership registration and annual-return duty confirms that, under current law, no such duty exists.
The status matters. This is proposed, not enacted, as a comprehensive law as of mid-2026, and elements have been floated for inclusion in Arrangements Laws. The current law remains the pre-2021 regime set out above. Because Arrangements-Law activity in 2025 and 2026 is live, the latest legislative status should be checked before any planning decision.
For the professional desk Three traps recur in this area. First, the two-Ordinance problem. Always label a Section 61 or a Section 63 with its Ordinance, because the income tax transparency rule and the limited-partnership rules share the same numbers. Second, the realization events. A contribution of an asset into a partnership and a distribution of an asset out of it are taxable events under Circular 14/2003, not neutral transfers, a point clients frequently miss. Third, the US LLC. The Israeli member's credit position depends on making the irrevocable election under Circular 5/2004, and the election cannot be unwound later.
Frequently asked questions
Does a partnership pay income tax in Israel. No. It is not itself liable to income tax or assessed as a taxpayer. Each partner reports its share in its own return and attaches the declaratory partnership appendix, Form 1504. The partnership does not file an annual return of its own. A return on the partnership's income is delivered only at the assessing officer's demand under Section 63(a)(2).
What is sold when a partner sells out. Under the Supreme Court ruling in Sdot, the partner sells the right in the partnership as a single capital asset, taxed under the capital gains rules, and not a proportionate share of each underlying asset.
Is contributing an asset to a partnership tax-free. Not under the default rule of Circular 14/2003. A contribution in, and a distribution out, are realization events taxed at fair market value.
How is a US LLC taxed for an Israeli member. Israel treats the LLC as opaque, while the United States treats it as transparent. Circular 5/2004 lets the Israeli member elect to report the income currently and credit the US tax, but the election is irrevocable.
Is an Israeli partnership a resident under a tax treaty. A partnership is a treaty person, but it is a resident only to the extent its income is taxed as a resident's income, so treaty benefits generally flow to the partners.
Is the 2021 reform in force. No. It was proposed in 2021 and has not been enacted as a comprehensive law. The pre-2021 regime remains the law, and the latest status should be checked before relying on it.
Advising on a partnership structure in Israel
The firm advises Israeli and foreign partners, fund managers, and their advisors, on the taxation of partnerships in Israel and across borders. We would be glad to help if you are facing one of these:
- A foreign partner or fund weighing Israeli exposure, permanent establishment risk, and withholding on distributions.
- An Israeli member of a US LLC or another hybrid entity, deciding whether to make the Circular 5/2004 election.
- A sale, restructuring, or liquidation of a partnership interest, where the Sdot characterization and the cost-of-the-right computation drive the result.
KLF Law is a firm specializing in taxation, with a focus on cross-border practice between Israel and other jurisdictions. To get in touch: royk@klf.co.il
About the author
Roy Kariv is an attorney and international tax advisor, owner and founder of KLF Law. A former prosecutor in the Special Cases Unit of the Israel Tax Authority, with more than a decade of cross-border practice. Founder of ktAi, a cross-border tax AI infrastructure.
