The Ministry of Finance is considering imposing a dedicated tax on computing facilities due to the burden on the electricity grid. How is such a move expected to affect entrepreneurs' bottom line, and how can strategic tax planning turn the threat into an economic opportunity?
The artificial intelligence revolution has created enormous demand in recent years for computing and data storage infrastructure. Many income-producing real estate companies have realized that walls and a roof are no longer enough and have begun investing significant capital in converting logistics buildings into advanced data centers. At first glance, this shift appears to be a natural and necessary business move. Beneath the surface, however, a regulatory and tax risk is emerging that is currently occupying government ministries. The main issue is that data centers consume vast amounts of electricity. An average facility requires a connection capacity equivalent to the consumption of tens of thousands of households. This creates an unprecedented burden on the national electricity grid, particularly in high-demand areas in central Israel.
Recognizing that Israel’s energy sector is under pressure, government teams are now examining ways to cool demand and redirect it to other areas. Among the solutions being discussed is the possibility of imposing a special tax on data centers, or alternatively setting a differential electricity tariff for heavy consumers of this type.
Once the state increases the basic electricity cost of the project, it effectively creates an indirect tax that directly cuts into the entrepreneur's operating profit line and changes the entire business model on which the investment was based
Electricity expenses are the largest and most fixed operating expense in data centers. An entrepreneur who built a project in central Israel and priced its services to high-tech companies based on standard industrial electricity costs will find it very difficult to reopen existing contracts and pass the new “electricity tax” on to customers. The result is a dramatic erosion of profitability. Beyond that, new projects in overloaded areas may face a simple refusal to connect to the electricity grid. This leaves the entrepreneur with an expensive real estate asset that cannot operate, while absorbing heavy financing costs each month that passes.
The way to address these changes is through early preparation and smart tax planning, using existing legislation to turn the threat into an opportunity. The Law for the Encouragement of Capital Investments is a central tool in this context. The state wants to encourage entrepreneurs to establish their data centers in peripheral areas, away from the load centers of the Tel Aviv metropolitan area. A company that purchases land and establishes a computing facility in Development Area A (such as the Negev or the Galilee) may apply for recognition as a “Preferred Enterprise.” This definition is not reserved only for factories that manufacture physical products. A data center that provides cloud and data storage services to foreign customers and exports at least 25% of its services may fall within the definition of a Preferred Technological Enterprise.
The tax significance of such a move is dramatic. A regular company in Israel pays corporate tax at a rate of 23%. A company operating in Development area A and meeting the conditions of the Law for the Encouragement of Capital Investments pays a reduced corporate tax rate of only 7.5%. Moreover, when the company wishes to distribute profits, the dividend tax for shareholders will be 20% instead of the regular rate of 25% to 33%. These benefits not only offset the costs of relocation or establishment in the periphery but also create long-term profitability that no project in central Israel can compete with, especially if new electricity taxes are imposed on it.
For further reading on the Law for the Encouragement of Capital Investments, click here.
Green Energy
Another issue that fits into the tax planning of such projects relates to green energy. In view of concerns about the collapse of the electricity grid, regulators are considering requiring data center entrepreneurs to establish independent generation capabilities, for example through large-scale solar systems and energy storage facilities. Entrepreneurs who integrate these technologies may be able to utilize income tax regulations that allow accelerated depreciation for renewable energy generation equipment. Instead of deducting the cost of these expensive systems over many years, the company can claim the expense at very high rates already in the project’s first years of operation. This deduction significantly reduces taxable income, and often leaves the company with higher cash flow, enabling it to repay bank loans more quickly and stabilize the project.
Consider a scenario that reflects a classic dilemma facing entrepreneurs today. Suppose a group of investors plans to establish a data center and expects the project to generate a net profit of approximately ₪10 million per year. If they insist on establishing the facility in the Sharon region, they will pay corporate tax of ₪2.3 million. If they are also subject to an increased electricity tariff or a dedicated levy costing them an additional ₪1 million per year, they will be left with a profit of ₪6.7 million. By contrast, if the same group establishes the facility in a preferred development area in the Negev, it will avoid exposure to the electricity tax. In addition, it will pay reduced corporate tax of 7.5%, amounting to only ₪750,000. In this scenario, the company is left behind with a net profit of ₪9.25 million each year. The gap of more than ₪2.5 million highlights how critical location and tax planning are.
At our firm, we have seen first-hand cases in which an understanding of the regulatory map prevented very costly mistakes.
The data center sector in Israel is at a crossroads. The business potential is clear, but the state will not allow the market to develop in a way that threatens the electricity grid without stricter regulation. Entrepreneurs who understand that tax can appear in different forms – through direct legislation or through electricity tariffs – can prepare in advance. Establishing the right corporate structures, choosing a location that enables entry into a benefits track under the Law for the Encouragement of Capital Investments, and making prudent use of depreciation expenses are the active steps that preserve the bottom line and ensure stability in the face of any government measure.
Nimrod Yaron & Co. specializes in Israeli and international taxation. Our team is composed of professionals with years of experience at the Israel Tax Authority, together with experience at leading firms and law offices, bringing a combination of legal and economic perspective. We advise private and public companies, Israeli and foreign companies, global venture capital funds, and clients seeking focused advice in clear and accessible language. We also work with a professional network of accounting firms and law firms around the world, in order to provide comprehensive support in cross-border matters. Just before you commit to high establishment costs in your next infrastructure project, we invite you to schedule a meeting. Together, we will analyze the project’s tax model, examine your eligibility for benefits under the Law for the Encouragement of Capital Investments, and ensure that you are properly prepared for any regulatory change.
FAQ
Why is the Ministry of Finance considering intervening in the taxation of data centers?
The intervention is being considered due to the exceptional electricity consumption of these facilities, which creates a heavy burden on the transmission and transformation grid, especially in central areas.
How does a differential electricity tariff affect the project's taxation?
An increased tariff effectively functions as an indirect tax. It permanently increases operating expenses and directly harms the company’s net profit line.
Can a data center receive Preferred Enterprise benefits?
Yes. If the data center is established in a development area and exports services (such as cloud services) to foreign customers, it may benefit from reduced corporate tax.
What is the tax advantage of integrating green energy systems into a data center?
The installation of solar systems and energy storage may allow the claiming of accelerated depreciation, which reduces taxable income and generates positive cash flow.
