The Ministry of Finance and the Israel Tax Authority have published a revolutionary draft of regulations aimed at changing the taxation rules on securities investments via investment funds and partnerships. The regulations, titled "Draft Income Tax Regulations (Benefits for Investors in Securities or Financial Assets), 5786-2025," propose a fundamental overhaul of the taxation method for private investment funds and their partners, with the goal of bolstering Israel's attractiveness as a destination for venture capital and high-tech investments.
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Highlights of the Proposed Benefits

• Classification as Capital Gain: The income of an "Eligible Limited Partner" (a passive investor) from the sale of securities by the partnership will be classified as Capital Gain, rather than business income.
• Exemption for Foreign Investors: A broad tax exemption on capital gains will apply to foreign residents investing through partnerships, alongside a specific exemption for investments in technology companies.
• Reduced Tax on Carried Interest: The tax rate on "Carried Interest" (success fees) for Managing Partners (who are not passive) residing in Israel will be capped at 27%.
• "Preferred Fund" Track: A dedicated benefits track will be established for a "Preferred Private Investment Fund" meeting specific conditions, which will include an exemption on interest and dividend income for certain foreign investors.
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Background: The Tax Challenge of Investment Funds in Israel

Under the current legal situation, the activity of investment funds is often classified as a "business," and their income is considered business income under Section 2(1) of the Ordinance. This classification "flows through" to the partners in the fund, such that even passive investors—including foreign residents—are deemed to have business income in Israel.
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This situation creates a significant barrier to investment, as it imposes high tax liability and complex reporting obligations on passive investors, contrary to the norm in many other jurisdictions where such income is taxed as capital gains. The draft regulations aim to resolve this barrier and align the Israeli tax regime with global standards.
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The Core Revolution: Classifying Passive Investors' Income as Capital Gain

The most significant change proposed by the regulations is the establishment of a new rule for an "Eligible Limited Partner." By definition, this is a passive partner who does not participate in the ongoing management of the partnership's business, does not take an active part in identifying or managing investments, and holds limited voting rights.
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The regulations stipulate that the portion of income attributed to such a partner from the sale of a security by the partnership will be considered Capital Gain. This reclassification distinguishes between the passive investor and the Managing Partner (General Partner) and allows the investor to enjoy reduced tax rates applicable to capital gains, instead of the high marginal tax rates applicable to business income.
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Targeted Benefits for Foreign Investors and Tech Companies

To encourage foreign investment, the regulations expand existing exemptions for foreign residents. It is determined that the provisions for capital gains tax exemption for a foreign resident (under Sections 97(B)(2) or (B)(3) of the Ordinance) will apply even if the capital gain was generated through a Permanent Establishment (PE) of the partnership in Israel.
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Additionally, the regulations propose a specific benefit for the technology sector: a foreign resident will be exempt from tax on income or capital gain from the sale of a security purchased within the framework of a "Qualifying Investment in a Technological Company." This benefit is designed to incentivize direct investments in Israeli high-tech companies.
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"Preferred Private Investment Fund": An Expanded Benefits Track

The regulations create a special track for a "Preferred Private Investment Fund"—a limited partnership meeting strict criteria designed to ensure a significant contribution to the Israeli economy. Conditions include:
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• Investment Volume: Investment of at least
• 10million∗∗in"QualifyingInvestments"or∗∗10million∗∗in"QualifyingInvestments"or∗∗5 million in technology companies.
• Investor Dispersion: No single partner holds more than 20% of the rights in the fund.
• Foreign Investor Majority: Limited partners who are foreign residents hold at least 30% of the rights.
• Investment Diversification: Investment in a single company shall not exceed 25% of the fund's total commitments.
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A fund meeting these conditions will entitle its partners to additional benefits, the primary one being a tax exemption for an "Exempt Foreign Resident" (such as a foreign pension fund or foreign sovereign entity) on interest and dividend income derived from a qualifying investment of the fund.
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Relief for Managing Partners: Reduced Tax on Carried Interest

The regulations also address Managing Partners (who are not "Eligible Limited Partners") and propose a significant benefit. It is determined that the income of these partners, deriving from their entitlement to Carried Interest (success fees) from the fund's profits, will be taxed at a rate of up to 27%.
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This stands in contrast to the current situation where this income is often classified as business income liable to marginal tax, which can reach approximately 50%.

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