The Israel Tax Authority (ITA) has recently issued guidance clarifying the distinction between technological and marketing income derived from intellectual property (IP), a classification that has significant implications for tax benefits under Israeli law. This distinction is particularly important against the backdrop of Israel’s efforts to align its tax incentives for the high-tech sector with international standards set by the Organisation for Economic Co-operation and Development (OECD).
Israel’s Law for the Encouragement of Capital Investments, enacted in 1959, offers reduced corporate tax rates on preferred income earned by qualifying industrial and technology enterprises. Companies operating in designated development areas benefit from a corporate tax rate as low as 7.5%, while others pay 16%, both rates applying indefinitely. Dividends are typically taxed at 20%, resulting in a combined profit tax burden ranging between approximately 26% and 33%, subject to applicable tax treaties. Large enterprises with revenues exceeding NIS 10 billion may qualify for lower rates.
These incentives fall within the purview of the OECD’s Base Erosion and Profit Shifting (BEPS) project, particularly Action 5, which aims to prevent "phony" preferential tax regimes by requiring countries to restrict benefits to income generated from substantial domestic activities. The OECD specifically limits tax breaks to income derived from patents or assets “functionally equivalent to patents.” Such assets include patents that have been broadly denied, certain copyrighted software, and in some cases, other nonobvious, useful, and novel IP assets that are legally protected and registered.
The Israel Encouragement Law implements these principles by restricting tax benefits to income emanating from “preferred intangible assets,” explicitly excluding marketing-related intangible assets. Marketing income—associated with assets such as brands, trade names, client lists, and contact information—is therefore not eligible for the preferential tax rates. The ITA’s new circular clarifies that marketing IP is an intangible asset that supports sales and marketing efforts but does not constitute qualifying technological IP.
Previously, regulations allowed marketing income to constitute up to 10% of total technological income without necessitating separate allocation. The latest circular eases the conditions for qualifying for this exception, providing several scenarios where income should not be classified as marketing income. These include business-to-business (B2B) or business-to-government (B2G) sales, transactions based on technical or regulatory requirements, sales of components integrated into a final product losing separate identity, and cases where usage rights are granted for extended periods to other companies developing preferred intangible assets, with royalty income typically excluded from marketing classification. Furthermore, where competition is minimal due to product uniqueness, or where marketing expenses are low relative to research and development spending, income may also avoid being categorized as marketing-related.
Given the complexity surrounding the differentiation of marketing versus technological income, the circular mandates that local tax offices refer income allocation issues to the ITA’s national-level Professional Division. Decisions and best-judgment assessments require approval by senior officials within this division, establishing a centralized authority aimed at ensuring consistent and predictable tax treatment for the high-tech industry.
Industry observers view the ITA’s approach as a constructive step to reduce disputes and enhance tax certainty for Israeli technology companies and multinational corporations performing R&D activities in Israel. Additionally, multinational firms can remunerate Israeli R&D subsidiaries on a cost-plus-10% basis under applicable Encouragement Law provisions.
As the ITA’s circular underscores, consultation with experienced tax advisors remains essential for companies navigating the nuances of IP classification and tax benefits across jurisdictions.