US President Donald Trump dropped a bombshell yesterday. His tax reform, which the director of the US National Economic Council called, "one of the biggest tax cuts in American history," spans borders and oceans, and is reverberating in many different countries, from miniscule tax shelters to developed Western countries.
Israel also cannot remain indifferent to this ambitious plan. Despite all the obstacles that it must pass, the apparent loopholes in it and the lack of clarity about how to plug them, and the fact that it is still unknown which parts of it will actually be passed, if any, intense analyses of the consequences of the reform for Israel and Israelis is already taking place.
Is the reform good or bad for Israel? Will cutting the corporate tax rate to 15% and canceling the US inheritance tax affect the Israeli public, and if so, will it be for better or for worse? It depends from what angle you look at it. At the level of companies and the individual Israeli, it could set in motion a movement of Israeli money to the US, a tax saving for immigrant investors, and handsome profits. At the national and tax revenue level, it seems that Trump is dipping his hand into the state treasury of Israel and other countries. The tax balance between the world's countries will change.
Adv. and CPA Daniel Paserman of the Gornitzky & Co. law firm says, "The tax reform presented by the Trump administration will fundamentally change the tax balance between countries, and is also likely to have a dramatic effect in the context of Israel."
According to Paserman, the current US tax regime is tax-heavy, and runs counter to the global trend towards lowering tax rates in order to attract investors. "Business activity in the US can be taxed at 35-40% tax rates. In comparison with other countries around the world, including Israel, this is an extremely high rate." In addition, Paserman explains that foreign investments in the US, even passive ones, including real estate and the capital market, for example, can be subject to 40% inheritance tax.
"On the other hand," he adds, "many countries around the world are lowering their tax rates, and are also offering special tax rates designed to attract international companies and foreign investors. For example, the UK is cutting corporate taxation to less than 20%, the Netherlands is offering a special tax regime for intellectual property, and Italy is offering a non domicile regime similar to the UK regime and, in certain cases, also to Israeli immigrant law, which grants tax benefits to new immigrants."
Paserman says that with the background of this situation and the global struggle for capital and business activity, and taking into account the growing financial difficulties and unemployment all over the world, "Trump's reform is very smart from the US perspective. The reform will result in US and international companies returning their activity to the US, thereby increasing employment and greasing the wheels of the US economy. Elimination of inheritance tax will make foreign investments in the US more attractive," he explains.
Dramatic change in global business and economic policy
For Israel, Paserman remarks, there is no doubt that if the reform passes, it will be a very significant change for the Israeli economy, especially the high-tech industry.
"In the past, Israeli entrepreneurs founded foreign companies holding intellectual property. At the beginning of the century, it was customary to establish US corporations, because it was believed that US companies and investors would prefer investing in US corporations. This attitude has changed in recent years, and the trend has reversed, with intellectual property returning to Israel. One recent well-known example is Mobileye(NYSE: MBLY), which began as an Israeli company in the 1990s, became a foreign company, and then returned to Israel, before being sold to US company Intel.
"The Law for the Encouragement of Capital Investment offers a very attractive tax environment, and recently - following the base erosion and profit shifting (BEPS) recommendations - the law has also been amended and tax rates further reduced, so that they now range between 5% and 16%.
"Now, following the reform being proposed by Trump, the tax gap between the US and Israel will narrow substantially, and in certain circumstances, US tax rates will be lower than those in Israel." In such a tax environment, Paserman asserts, and considering that the US market and US companies are the main target, there is no doubt that Israeli entrepreneurs are likely to prefer locating their businesses in the US, rather than Israel.
"If the Trump reform really passes, Israel will have to rethink its high-tech track, and even Mobileye's autonomous car won't help," Paserman declares.
Tax boutique owner and former Income Tax Commissioner Tali Yaron-Eldar believes that Trump has decided to get on the international tax cutting bandwagon.
"Trump is joining a long list of countries that have realized that lower tax rates will bring more business. The best known of these are Ireland, where the corporate tax rate is 12%; Cyprus, where it is 12.5%; Malta, with an especially low 5% rate; and Panama, with 10% corporate taxation."
It is not definite, however, Yaron-Eldar says, that this measure is a wise one. "Because the US is an important target country, it does not have to be the cheapest one from a tax standpoint in order to bring business to it. It can even be a little more expensive than others, in the knowledge that it is critical to the success of companies, particularly with respect to technology."
In any case, Yaron-Eldar agrees that this reform will bring about a dramatic change in global business and economic policy. "If the proposed reform really passes, we will see a significant movement of business activity to the US. Later, in my opinion, in order to keep activity in their territory, other countries will be forced to cut their taxes even further in order to avoid driving business away from them. The truth is that no large margins are left for cutting taxes, and this is true for both Israel companies and international companies originating in Israel, because in considering whether to operate in Israel or the US when tax rates are the same, there is no doubt that if the reform is approved, many companies will move most of their business, albeit gradually, to the US."
Adv. Binyamin Tovi, international taxation partner at the Shekel & Co. law firm, agrees. He says, "The consequences of Trump's taxation plan are liable to be dramatic for Israel, diverting profits from Israel to the US and thereby reducing taxes paid in Israel."
According to Tovi, even though certain high-tech companies already benefit from low tax rates (5-16%) in Israel under the Law for the Encouragement of Capital Investment, the many conditions for obtaining the reduced tax rates are liable to lead companies to move their activity to the US.
"The solution for preventing a flight of high-tech companies from Israel to the US does not lie in another cut in corporate taxes," Tovi declares, "but in making the conditions for obtaining the benefits in Israel more flexible."
US becoming a tax shelter
International taxation specialist Adv. Yair Benjamini says that attention should be paid to another effect of the plan to reduce the US corporate tax rate to 15% - the effect on US companies operating in Israel.
"As soon as the US corporate tax rate drops to 15%, the Israel Tax Authority is liable to treat a US company with over 50% passive revenue and Israeli shareholders as a 'foreign-controlled company,' This clause was enacted at the time in order to prevent Israelis from accumulating passive revenue in off-shore companies, but for the legislator, 15% corporate tax has to be treated like a tax shelter company, so that the US becomes a kind of tax shelter where Israeli law is concerned," Benjamini predicts.
Benjamini says that this change in the perception of foreign companies in Israel will be particularly relevant to companies holding real estate in the US, especially when the real estate involved is commercial real estate or an investment in rental residential real estate. Benjamini also agrees with other tax experts, however, that the bitter consequence of the reform for the state treasury is a flight of money to the US.
"Cutting the US corporate tax rate is likely to give Israeli companies with parent companies or subsidiaries in the US an incentive for diverting their business profits from Israel to the US," Benjamini explains, adding, "We expect that, as a result, the inclination of the Ministry of Finance to cut corporate taxation will become stronger on the one hand, and companies will be exposed to tighter audit by Israel Tax Authority inspectors on the other."
Published by Globes [online], Israel Business News - www.globes-online.com - on April 27, 2017
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