Minister of Finance Moshe Kahlon is promoting a proposal for a reduced tax track for high-tech companies in the Economic Arrangements Bill. Sources close to Kahlon say that unless corporate taxation is reduced, high-tech companies will move their development centers, responsible for half the output of Israel's high-tech sector, away from Israel. Kahlon appointed Ministry of Finance director general Shai Babad to head a team for formulating recommendations on taxation of high-tech companies in anticipation of a change in the international rules.
According to the proposal prepared by Babad's team, large high-tech companies (with a business turnover of over NIS 10 billion) will pay 6% companies tax and 4% tax on dividends. Small high-tech companies will pay 12% companies tax and 4% tax on dividends.
The current maximum tax rates in Israel are 25% companies tax and 20% tax on dividends. In practice, under the Law for the Encouragement of Capital Investments, high-tech companies already enjoy a reduced tax rate of 16% for exporters and 9% for exporters with production facilities located in outlying areas.
Another taxation track, called "strategic," which was granted to Intel in Kiryat Gat, offers a reduced 5-8% tax rate, subject to detailed employment and other requirements. The Ministry of Finance stresses that the existing tracks will not be changed. Entry into the new track is contingent on the company meeting the definition of a high-tech company, which was devised in the recommendations for the first time. In order to be considered a high-tech company, a company must show that at least 7% of its expenses are for R&D, and must also fulfill one of three conditions: 20% of its employees are employed in development, a venture capital fund formerly invested in the company, and the company averaged 25% growth in sales or staff over the past three years.
The background for the initiative is the fact that many international companies, such as Google, Apple Computers, Microsoft, IBM, and others, maintain development centers in Israel employing thousands of workers.
These centers generate a huge profit for the companies, derived from the intellectual property products they are developing, but the companies pay no tax on this profit, because they take advantage of a loophole: the tax on intellectual property profits is paid in the country where the intellectual property was developed. As a result, major international companies have registered their intellectual property in tax shelters, and have ordered work from the development centers as if they were making an order from a contractor. Israel therefore does not benefit from taxes paid by companies operating here, except for income tax paid by employees of these companies and VAT on their payments to local suppliers.
This situation has affect the tax revenues of other countries and set in motion the base erosion and profit shifting (BEPS) process, which has led to new tax rules preventing high-tech companies from splitting the registration of their intellectual property from the country in which it was developed. These rules went into effect last month for new companies, while existing companies have been allowed five years to prepare.
The Ministry of Finance says that companies prefer to leave their development centers in Israel, but under the current tax regime, will prefer moving to countries like Ireland or Singapore, which offer substantially lower taxation. On the other hand, Kahlon's officials believe that reducing the tax rate to the proposed levels will attract billions of dollars in investment to Israel, and substantially increase state tax revenues from high-tech companies, which pay almost no tax at all at present. They also emphasize that the fact that the new tax track is green, meaning that a company will be entitled to reduced tax without having to obtain approval from the Israel Tax Authority, beyond the fact that they are a high-tech company according to the criteria.
Companies that do not fulfill the criteria, and which nevertheless seek recognition as a high-tech company, can request such recognition from the Ministry of the Economy and Industry Chief Scientist, who will have discretion to recognize them as high-tech companies nevertheless.
Published by Globes [online], Israel business news - www.globes-online.com - on July 14, 2016
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