IsraelLawDeductible Business Expenses in Israel: What Self-Employed and Foreign Business Owners Can Claim
If you run a business in Israel — whether as a self-employed individual (עוסק מורשה), through an Israeli company, or as a foreign entity with Israeli operations — understanding what you can deduct is one of the highest-value things you can do for your tax position. Israeli tax law is not structured like a simple checklist. The Income Tax Ordinance sets out a general principle, then carves out specific limitations that override it. Getting this wrong costs real money.
This guide covers the rules that apply to most businesses operating in Israel, with particular attention to situations that commonly trip up foreign nationals, expat entrepreneurs, and multinationals with Israeli subsidiaries or branches.
Section 17 and the "wholly and exclusively" rule
Section 17 of the Income Tax Ordinance 5721-1961 (*פקודת מס הכנסה*) is where Israeli business tax deductibility begins. It allows a deduction for "an expense or loss incurred wholly in the production of income in the tax year." Courts have read this to require that the expense be incurred both wholly and exclusively for business purposes.
The Israel Tax Authority applies this two-part test as follows:
- Wholly: the entire expenditure — not just part of it — was directed at producing income. An expense that partly serves a private purpose fails this test unless a specific provision allows partial deduction.
- Exclusively: producing income must be the sole purpose. An expense that was also motivated by personal benefit, prestige, or relationship-building (without a demonstrable business return) is at risk.
What Section 17 does not do is provide a list. That job falls to Sections 18-32, which either confirm specific categories as deductible or cap them at a percentage. When a later section explicitly limits a deduction, it overrides the general Section 17 permission, even if you can show the expense was 100% for business. The cap applies regardless.
Fully deductible operating expenses
The following categories are deductible in full when properly documented and clearly tied to income-producing activity:
- Rent: Office, workshop, or retail premises leased for business use. If the lease covers mixed residential and commercial space, only the commercial portion qualifies.
- Salaries and employer contributions: Employee wages, severance fund deposits (keren hishtalmut and pension components), and the employer's share of National Insurance contributions (Bituach Leumi) — approximately 6.5% on wages up to the monthly income ceiling set by the National Insurance Institute (NII).
- Professional and consulting fees: Accountant, attorney, tax advisor, and management consultant fees paid for business-related services.
- Raw materials and inventory: The cost of goods actually sold during the tax year.
- Telecommunications: Business phone lines, internet, and dedicated mobile plans. Where a single plan covers personal and business use, the business proportion must be established by evidence.
- Insurance premiums: Liability, property, directors' and officers', and professional indemnity insurance for the business.
- Advertising and marketing: Website development, online advertising, trade fair participation, and promotional materials.
- Bank charges and business loan interest: Interest on loans used for business operations — provided documentation shows the loan proceeds were applied to the business and not to personal use.
- Bad debts: Written-off debts previously included in taxable income are deductible when the debt becomes genuinely uncollectible. The ITA typically requires evidence of collection efforts before accepting the write-off.
Partially deductible expenses
Three expense categories are subject to explicit statutory caps. These limits apply regardless of how convincingly you can argue the expense was 100% for business.
Vehicles (Section 30)
If a company provides a vehicle to an owner, director, or employee, only 45% of vehicle expenses (fuel, maintenance, insurance, leasing costs) are deductible as a business expense. The remaining 55% is treated as a taxable fringe benefit in the hands of the recipient, calculated using the ITA's "use value" table updated each year.
Self-employed individuals who own their own vehicle may deduct actual business-use costs in proportion to business mileage. The ITA requires a contemporaneous yoman nesiot (יומן נסיעות) — a mileage log recording the date, destination, purpose, and kilometers for each trip. A log reconstructed at year-end is generally rejected.
Home office (Section 18(b))
Self-employed persons who work from home may deduct a proportionate share of home expenses — typically capped at 25% of rent, municipal tax (arnona), and utilities — provided a dedicated workspace exists. The space must be used primarily for business, not as a dual-purpose family room or bedroom. Some assessors request a floor plan or photographs. Homeowners may deduct the equivalent rental value of the dedicated area rather than mortgage interest.
Meals and entertainment (Section 32(11))
Business meals with clients, suppliers, or employees are deductible at 80% of actual cost. Pure entertainment expenses — sporting events, theater, hospitality packages — are not deductible unless the business purpose is clearly documented. Restaurant bills should show the number of diners; you should keep a note of who attended and what business matter was discussed.
Capital vs. revenue expenditures
Israeli tax law draws a firm line between expenses that are consumed in the current year (revenue expenditures, deductible now) and assets with a multi-year useful life (capital expenditures, depreciated over time). Getting this wrong, whether by deducting capital items immediately or by spreading revenue items incorrectly, will attract correction on assessment.
Revenue expenditures include anything that is used up in producing this year's income: rent, wages, supplies, advertising, and ongoing maintenance. These are deductible in the year incurred.
Capital expenditures include assets that last beyond the current tax year: equipment, computers, vehicles, furniture, software licenses with multi-year terms, and leasehold improvements. These are not deductible on acquisition but are depreciated under regulations issued pursuant to Section 21 of the Ordinance.
One area that frequently causes confusion is repairs versus improvements. A repair that restores an asset to its original working condition is a revenue expense. An improvement that materially enhances an asset's value or extends its useful life is a capital expense. Repainting office walls is a revenue expense; adding a new floor is capital.
Depreciation rates for common assets
The ITA publishes depreciation schedules (שיעורי פחת) under regulations issued pursuant to Section 21. All rates below are straight-line (percentage of original cost per year) unless otherwise noted.
| Asset type | Annual rate |
|---|---|
| Computers and peripherals | 33% |
| Office furniture and fixtures | 6–10% |
| Machinery and manufacturing equipment | 15% |
| Passenger vehicles | 15% |
| Commercial buildings | 4% |
| Leasehold improvements | 10% or over lease term |
| Software (purchased) | 33% |
| Patents and intellectual property | Varies — typically 5–20% |
Depreciation begins from the date the asset enters productive use, not the date of purchase. An asset bought in December but not installed until January of the following year starts depreciating in the following year.
Documentation requirements
Every deductible expense must be backed by appropriate documentation. Israeli law does not allow verbal or reconstructed records — contemporaneous paperwork is required.
- VAT invoice (חשבונית מס): For purchases from Israeli VAT-registered businesses, you need a full tax invoice showing the supplier's registered business number (מספר עוסק מורשה), your own business number, date, description of goods or services, and the amount split between net price and VAT. Without a proper חשבונית מס, you cannot claim input VAT and the ITA may also disallow the income tax deduction.
- Foreign invoices: Acceptable for services purchased abroad but may require certified Hebrew translation in an audit. Bank records confirming payment are essential.
- Payroll records: Monthly payroll must be accompanied by Form 102 filings with the ITA and Bituach Leumi. At year-end, each employee receives a Form 106 (certificate of income and deductions).
- Retention period: Documents must be kept for 7 years from the end of the relevant tax year. Digital storage is accepted provided records are organized, searchable, and accessible on ITA request — including in machine-readable format for businesses using accounting software.
Pitfalls for foreign business owners
Several issues appear repeatedly in audits of foreign-owned Israeli businesses. Being aware of them before filing is far less costly than resolving them afterward.
Unintentional permanent establishment
A foreign company that has employees in Israel, maintains an Israeli office, or operates through a dependent agent with authority to conclude contracts may inadvertently create a Permanent Establishment (PE). Once an Israeli PE exists, income attributable to it is subject to Israeli corporate tax at the flat rate of 23%. Expenses properly allocated to the PE are deductible — but the allocation methodology needs documentation. Companies that discover a retrospective PE face back-tax exposure plus interest.
Transfer pricing on intragroup transactions
If your Israeli entity pays management fees, royalties, or interest to its foreign parent or related entities, those payments are subject to transfer pricing rules under Section 85A of the Ordinance. The ITA requires that intragroup prices reflect arm's-length rates. Fees the ITA considers excessive are disallowed as deductions; fees considered too low may be reclassified as deemed dividends subject to withholding tax. Document your transfer pricing methodology in advance — an intercompany agreement and a transfer pricing study are the standard defense.
Currency conversion errors
Israeli income tax is calculated in New Israeli Shekel. When a foreign-currency invoice is received, the NIS equivalent is calculated at the Bank of Israel representative rate on the transaction date. Using a different rate — even the rate shown on your bank statement, which may differ by a day — creates discrepancies that ITA systems flag automatically. Use the Bank of Israel's published daily rate for all conversions.
VAT registration threshold
Non-resident businesses making taxable supplies in Israel above the annual registration threshold are required to register for Israeli VAT (מע"מ). Without registration, you cannot issue valid VAT invoices (חשבוניות מס), which means Israeli business clients cannot claim input VAT on what they pay you. This creates a concrete commercial disadvantage and potential contractual disputes. Check the current ITA threshold — it is adjusted periodically — when assessing whether Israeli operations require registration.
Mixed-use assets claimed as 100% business
The ITA regularly questions assets — vehicles, mobile phones, laptops — claimed as 100% business use when the owner or employee uses the same asset personally. The burden of proof lies with the taxpayer. If you cannot substantiate full business use through logs and records, the ITA will impose the statutory caps or deny the deduction entirely.
Frequently asked questions
Generally, no. Section 17 allows deductions only for expenses incurred in producing income. Pre-revenue startup costs — incorporation fees, market research, and initial equipment purchases — are typically capital expenditures rather than immediately deductible operating costs. Some formation costs may be amortized over the first few operating years; an Israeli accountant can advise on how to structure these correctly from the outset.
Yes, when the training directly relates to your current trade or profession. A software developer attending a coding course or a lawyer completing a continuing education seminar can deduct the cost. Training aimed at an entirely different career is not deductible. Courses held abroad that combine travel with leisure receive heightened scrutiny from the ITA; attendance records and a program showing the course was the trip's primary purpose are important to keep.
The ITA issues a tax assessment (שומה) that adds the disallowed amount back to your taxable income, recalculates the tax owed, and charges interest at the statutory rate from the original payment date. You have 30 days to file a formal objection (השגה) with the assessing officer. If the objection fails, you may appeal to the District Court within 30 days of the objection decision. Most routine deduction disputes are resolved at the objection stage when the taxpayer provides the missing documentation.
A foreign company pays the Israeli consultant and deducts those fees under its home-country tax rules. In Israel, the consultant declares the income and pays Israeli tax on it. If the paying foreign company has a PE in Israel, fees allocated to that PE are deductible against Israeli-source income under Section 17. The Israeli entity making the payment is generally required to withhold income tax from self-employed consultant fees unless the consultant holds a withholding exemption certificate (פטור מניכוי במקור) issued by the ITA.
Donations to Israeli non-profit organizations recognized under Section 46 of the Ordinance (registered amutot and public benefit companies) are deductible up to 30% of taxable income. There is a minimum donation amount — adjusted annually by the ITA — below which no deduction is available. Donations above the annual cap may generate a tax credit. The charity must provide a receipt confirming its Section 46 recognition status; without it, the deduction will be denied.