Since January 1, 2026, an Israeli business that fails to withhold tax from a payment subject to withholding risks losing the deduction for that expense. This is the amendment to section 32A of the Income Tax Ordinance, passed in the 2025 Arrangements Law. Until then, reporting the payment was enough. Now the tax withheld must also be passed on to the assessing officer. The officer may still allow the expense if it is shown that the recipient paid the tax themselves, or that there was no duty of withholding tax in the first place.
A self-employed person working from a room in a rented flat falls straight into that gap. The landlord is a private individual, the lease is a residential one, and no tenant withholds tax from the rent.
What the Knesset committee was told
At the Israel Tax Advisors Bureau conference in Eilat in October 2026, the Bureau's president, Yaron Gindi, described how this was settled. In his account, the Bureau agreed to back the amendment on one condition: a statement to the legislator, in committee, that failing to withhold tax from the share of residential rent that belongs to the office would not disqualify the expense. An assistant to the director of the Tax Authority said exactly that in the committee, in wording agreed in advance, and Gindi said he still has the WhatsApp message recording what was agreed.
The clarification made it into Income Tax Circular 03/2026, dated February 9, 2026. It says the disallowance does not apply to an expense that is mainly private, for example a property used as a home where part of it is set aside for business and no tax was withheld on the business part. Which use dominates is decided by floor area. The circular stresses that the relief concerns section 32A only, and the assessing officer still examines in an audit whether the expense itself is deductible.
Relief only from 2026
Moshe Kedar, a lawyer and accountant who represents taxpayers, welcomed the clarification and immediately took issue with it. In his view, the circular applies it only to payments from January 1, 2026, even though there is no real difference between a flat rented in 2025 and one rented in 2026. The circular does set that date as the start of the whole amendment.
A cost for the landlord
The Authority's representative added a warning. When the tenant claims part of the rent as a business expense, the landlord may lose the exemption on income from renting a residential flat for that part. He said the Authority did not write this into the legislation, but it can come up in the landlord's assessment. He reminded advisers that they often act for both sides of the same lease.
A doctor who rents an entire flat and runs a clinic in it is a different case. There the main use is business, and under the circular's floor-area test the relief does not apply. It is meant for a workroom inside a home people live in.
A self-employed tenant who works from a room can claim the share of the rent by floor area on payments from 2026 without withholding tax from the landlord. Keep the lease and a measurement of the room against the flat, since that is what the assessing officer will check. A landlord whose tenant works from home should allow for that share being examined on their side.