Israel's New R&D Tax Credit: The Biggest Shift in the Encouragement Laws in a Decade

Category: Encouragement Laws | Reading time: approx. 7 minutes

For years, one model stood at the heart of Israel's hi-tech incentive policy: reduced corporate tax rates for preferred and preferred technological enterprises. But the OECD's new global tax rules (the Pillar 2 reform), which set a 15% minimum tax for large multinational groups, eroded that model's effectiveness: what is a 7.5% corporate rate worth if another country collects the difference? Israel's answer: the Encouragement and Incentive of Research and Development Law, 5786-2026 — a shift to an R&D expense tax credit model, of the kind well known worldwide (R&D Tax Credit), structured to survive Pillar 2 rules.

Who Qualifies? The "Qualifying Group" — A High Bar

Let's be honest up front: the law targets large technology and industrial companies. Eligibility is tested at group level, with all of the following met in the tax year:

• Revenues of at least NIS 100 million (indexed) — the cumulative income of the group's Israeli companies from a preferred or preferred technological enterprise;
• The 55% test — preferred income constitutes at least 55% of the total revenues of the group's Israeli-resident companies;
• The employee test — at least 200 full-time employees in Israel, or an average of 200 over the tax year and the two preceding years (never fewer than 150 in any year). An employee working up to 4 hours a day counts as half;
• And each claiming company must be a "qualifying company" — a preferred company under the Capital Investment Encouragement Law.

Meaning: most startups and mid-size companies are still out. But note two points — the test is group-wide (several Israeli companies in the same group count together), and the bar is tested annually. A company growing toward 100 million, or a group organized correctly — can come within scope. That is exactly the kind of planning worth doing in advance.

Which R&D Expenses Count?

"Qualifying R&D expenses" are built in layers:

• R&D employee payroll in Israel — 100% of salary cost. The central component;
• Depreciation on productive assets used for R&D, and consumable equipment;
• Overhead — an automatic addition of 20% of R&D payroll cost, no itemized proof required;
• Subcontractors — expenses to an unrelated subcontractor are recognized at 65% (as are related-party costs where actual expenses are not proven);
• R&D abroad — generally excluded, save for narrow exceptions such as clinical and toxicology trials that cannot be performed in Israel.

The precise classification of "R&D activity" rests with the Innovation Authority — that is, approval is required that the activity is indeed research and development. This is a critical preparation point, addressed below.

The Benefit: Two Tiers, Huge Gaps

The credit rate depends on location and the nature of the activity, with a group "step" of about NIS 1.05 billion of R&D expenses (indexed):

• An enterprise in Development Area A or a special R&D enterprise — a credit of 25% of expenses up to the step, and 30% above it;
• Other qualifying companies — 3% up to the step and 4% above it.

The gap between 3% and 25% is deliberate: the state is using the law to draw R&D activity to the periphery and encourage large development centers. Even 3% is real money — a company with NIS 200 million of annual R&D spend is looking at a NIS 6 million annual credit — but for companies weighing where to locate new activity, the numbers reshape the decision.

The Big Innovation: A Credit That Becomes a Cash Grant

Here the law truly breaks ground. The credit offsets corporate tax in the year after the R&D year — but what if there is not enough tax to offset (a loss-making or scaling company)? The law provides: a credit unused within three years can be received in the fourth year as a cash grant — within 90 days of filing the notice, with indexation. A company can even elect the grant track in advance. In Pillar 2 terms, this structure (a qualified refundable tax credit, QRTC) is precisely what allows the benefit to survive the global minimum tax rules — which is what makes it attractive to giant multinational groups as well.

How Does It Integrate with the Preferred Technological Enterprise Track?

An important point: the new law does not replace the Capital Investment Encouragement Law tracks — it is built on top of them. Credit eligibility requires that the group's companies are preferred companies with income from a preferred or preferred technological enterprise — in other words, you must first be within the Capital Investment Encouragement Law, and only then does the additional credit layer open. In practice, two benefit layers emerge: a reduced tax rate on preferred income (12%, 7.5% or 6% by track and location) + an R&D credit on the expenses. And for large groups subject to Pillar 2, where the reduced rate is "topped up" to the global minimum anyway — the credit becomes the main benefit engine. Building the right mix between the layers is the heart of the planning.

What to Do Now? Preparing for 2026 Reports

The law applies to R&D expenses from January 1, 2026 — meaning the first eligibility year is already halfway through, and whatever is not documented properly this year will be hard to reconstruct. The immediate preparation steps:

1. Map the group and eligibility — which Israeli companies belong to the group, whether the 100-million, 55% and 200-employee tests are met, and which company will act as the representative filing the consolidated report for the group;
2. Separate R&D costs in the books — dedicated cost centers for R&D activity, so payroll, depreciation, consumables and subcontractors are identifiable and supportable. Mixed-role employees (R&D + another function) require a documented allocation mechanism;
3. Ongoing documentation — recording R&D projects, R&D employees' time logs, subcontractor agreements (distinguishing related from unrelated parties — the difference is 65% recognition or less), and a register of assets used in R&D for depreciation purposes;
4. Regulatory timelines — the application to the Innovation Authority is filed within 24 months of tax year-end, and the Authority must decide within 150 days (silence = approval). Sounds far off? Companies that build the infrastructure now will file first and gain early certainty;
5. Review location and structure — for companies considering expansion: the gap between 3% and 25% in Development Area A merits a strategic discussion, as does the upfront choice between the credit and grant tracks;
6. Integrate into the reporting framework — the allocation of the credit among group companies in the consolidated report is irrevocable — an allocation error cannot be fixed. That demands group-level tax planning before filing, not after.

The above article is provided for general information only and does not constitute professional advice or a substitute for specific consultation. The law's provisions are detailed and some will be anchored in guidance and regulations not yet fully published. For any question, you are welcome to contact us.

Sincerely,
Hager-Alperowitz & Co. — Certified Public Accountants