How should Israel respond to US tax reform? Carefully

Amiram Barkat

Lower US corporate tax rates are the least of Israel's worries.

Most Israeli government officials have reservations about a further cut in corporate taxation as a response to the US President Donald Trump's tax reform, "Globes" has found. Against a background of statements by Prime Minister Benjamin Netanyahu and Minister of Finance Moshe Kahlon on opening negotiations with the US on the matter, officials warn that Israel is liable to endanger its relations with other important trading partners if it does not conduct itself wisely and discreetly vis-a-vis the Americans. "This reform has raised a storm around the world. It's true that we have a special relationship with the US, but we mustn't flaunt it," government sources told "Globes".

The reform, which came into force at the beginning of the year, is mainly known for the reduction in US corporate tax rate from 35% to 21%, but, contrary to the impression that has been created, the concern in Israel is less about the tax rate reduction and more about other features of the reform that are liable to encourage major companies to move activities from Israel to the US. Prime Minister Benjamin Netanyahu has asked National Economic Council head Prof. Avi Simhon to present recommendations on the matter, and his report is due to be published in the next few days.

Government sources told "Globes" that the main fear in Israel arises from the effect of implementation of the reform on a small group of less than ten companies with business activity amounting to more than $500 million and that have significant activity in the US. This group, which includes Intel and Microsoft, and also Israel company Check Point Software Technologies Ltd. (Nasdaq: CHKP), is affected by various sections of the reform, but in ways that vary from one company to another. "Each company has its specific problems," the sources told "Globes", "and therefore the most desirable solution as far as we are concerned will not be based on cutting Companies Tax or on changing this or that section of the law but on dealing with each case individually. The tax reduction question is fairly marginal in this story."

Contrary to Trajtenberg's recommendations

Israel's Companies Tax rate is currently 23%, so that in theory a reduction to 21% puts the US ahead of Israel in what is known as "the race to the bottom". Because of this, Netanyahu and Kahlon were quick to declare that they were considering a further reduction in Companies Tax in Israel. This is contrary to the recommendations of the Trajtenberg committee, which found that the reduction in Companies Tax in 2012 indirectly contributed to a rise in the cost of living in Israel, and recommended raising the rate back to 25%.

Professional sources in the government say they do not believe that cutting Companies Tax will make Israel more competitive versus the US. Israel Tax Authority director Moshe Asher, who recently commented on the matter, explained that the full rate of Companies Tax (23%) is imposed in Israel on companies whose entire business is in the domestic market, and which are therefore unaffected by tax rates in the US. Companies that export to the US and other places already benefit from reduced rates of tax, between 7.5% and 16%, which are even lower than the new US rate. Giant companies like Intel pay even less tax, according to rates on a special taxation track called the "strategic" track.

What concerns government officials are other arrangements in the reform designed to reduce recognition for tax purposes of expenses incurred outside the US and restrict the offsetting of losses against profits. The logic behind these regulations is a switch from a global taxation method to a territorial method, which is the norm in most countries. "This is a dramatic reform, built around the motto 'whoever moves to the US will gain', that is, maximizing the advantages of the US environment and making it more business friendly than the environment in other countries, such as in Israel," a government source told "Globes".

One of the most worrying measures from Israel's point of view is called in the reform 'base erosion anti-abuse tax', or BEAT. This is designed to prevent companies transferring activity out of the US, and stipulates that US companies with turnover in excess of $500 million will be subject to a tax of 10%, not offsetable against profit, on payments to connected foreign companies, including expenditure on services, intellectual property, and interest payments. The problem for the Israeli companies is services, the fear being that expenditure on research and development will come within the definition of 'service'. This clause is especially relevant to a company like Check Point, which will be unable to set off research and development in Israel against US profits.

Another measure liable to be problematic, for a company like Intel for example, is what is called 'global intangible low-taxed income', or GILTI. This is a tax with an effective rate of 10.5% imposed on foreign activity. The problem is that tax already paid overseas on that activity is not recognized unless it is at a rate of 13.125% or more. Government officials see this as liable to affect the Israeli activity of companies like Intel or Microsoft, which class their activity here as "cost plus".

"Services and R&D are a critical matter for Israel," an Israeli source says. "As far as other countries, such as Switzerland, are concerned, the most sensitive point is registration of intellectual property. Each country will deal with this reform in accordance with its needs and sensitivities."

International sensitivities

Netanyahu's announcement that Israel will act vis-a-vis the US on the tax reform touches on the most sensitive matter from Israel's point of view: how to deal with the reform's problematic consequences. Government officials recommend extreme caution, in order to avoid endangering relations with other countries that, no less than Israel, see the reform as a substantial threat. "The greatest sensitivity here is not the reform but how the State of Israel deals with it," government sources told "Globes". "We are living in uncertainty over this, because we are one player among many. Until we see the response of the international community, and chiefly of powers like the EU and China, it would be a mistake for us to take the first step, because everything is inter-connected. If everyone else takes a certain step, it would be wrong for Israel to go off in the other direction.

"What's important is to see how the world behaves on this matter, what we can achieve vis-a-vis the Americans, and how we can ensure that Israel will continue to be attractive and create an environment that encourages the next startup. It's true that Israel has an open channel with the Americans and there's a tax treaty with the US that grants Israel unique advantages, but we have to be discreet about it."

Published by Globes [online], Israel business news - www.globes-online.com - on February 26, 2018

© Copyright of Globes Publisher Itonut (1983) Ltd. 2018

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