Your Taxes: Israeli tax breaks for business get even better

There are, in fact, two tax regimes for companies in Israel - regular and preferential. Following is a brief summary of the two.

By LEON HARRIS, SIGAL GRIBA
taxes 2 88 (photo credit: )
taxes 2 88
(photo credit: )
New regulations that have just been issued enable more firms in Israel to obtain tax breaks. There are, in fact, two tax regimes for companies in Israel - regular and preferential. Following is a brief summary of the two. Under the regular tax regime - in the Income Tax Ordinance - companies and their shareholders pay taxes on their profits at the following rates: * Company tax: 29% (which will drop to 25% by 2010). * Dividends paid to individual shareholders: 20% tax if the shareholder's interest is under 10%, otherwise 25% tax. (Separate rules apply to intercompany dividends). * Resulting total Israeli taxes on companies and their shareholders: 43.2%-46.75%. Under the preferential tax regime - in the Law for the Encouragement of Capital Investments - tax breaks are available automatically in qualifying cases for "Privileged Enterprises." * They are in the industrial, technology or hotel sectors. * Possible exemption on undistributed profits for two to 15 years, depending on the location and foreign ownership. (This suits investors hoping to enjoy capital gains from an exit rather than dividends). * Low company tax rates of 10% to 25% apply to distributed and subsequent profits. * Dividends are taxed at a rate of 4% or 15%, depending on the package selected. * Consequently, combined Israeli taxes for a Privileged Enterprise may range from 0% to 36.25%. * An Approved Enterprise in a development area will enjoy the same low taxes but no exemption. Instead it may receive fixed asset grants of 20%-32%. How does a company qualify for the preferential tax regime? This is now possible if certain conditions are met, without needing to obtain approval. The main conditions include: * The company has an "industrial enterprise" or a hotel. If industrial, the main activity in the tax year is productive - this may include software products and industrial research and development for a foreign resident that is approved by the Office of the Chief Scientist. * A "minimum qualifying investment" must be made in fixed assets in industry (or a hotel) in Israel - only NIS 300,000 over three years for new start-ups. For existing companies, the new investment must also exceed 5%-12% of the tax-depreciated value of fixed assets other than buildings at the end of the preceding tax year. * Privileged Enterprises and Approved Enterprises must be competitive and not overly dependent on the market of any one country - in practice, this translates into a 25% export requirement in all industries except biotechnology and nanotechnology. Suppose your company does not meet the export requirement and is not in the bio or nano sectors? The new regulations let companies enjoy the preferential tax regime if they supply components to other Israeli companies for incorporation in products which are exported. This is colloquially referred to as "indirect exports." To qualify, a number of conditions must be met, by the "indirect exporter" depending on the location, as follows: Criteria for enterprises in development area A: * Income from indirect export sales from any one market does not exceed 75% of total income. A market is a country or a customs union area, e.g. the EU or Hong Kong; or * At least 25% of their sales are to a market with at least 12 million residents. Criteria for enterprises in development area B: * Income from indirect export sales from any one market does not exceed 50% of total income; or * At least 50% of their sales are to a market with at least 12 million residents; and * Minimum sales of NIS 15 million. Criteria for enterprises in other areas (central Israel): * Income from indirect export sales from any one market does not exceed 50% of total income; or * At least 50% of their sales are to a market with at least 12 million residents; and * Minimum sales of NIS 20m. Alternative criteria for enterprises in development areas A and B: * Owned by a research and development company - at least 7% of total sales are invested in R&D and at least 20% of personnel hold academic qualifications in the fields of engineering, computers, life sciences and "exact sciences (e.g. physics, chemistry, mathematics); * Income from indirect export sales from any one market does not exceed 65% of total income; or * At least 35% of their sales are to a market with at least 12 million residents; and * Minimum sales of NIS 20m. The new regulations issued in 2007 have retroactive effect from the 2004 tax year. Therefore, if you are involved in an "indirect export" enterprise, this may be well worth checking out. To sum up, it just became easier to qualify for Israel's preferential tax regime for companies. The regular tax regime also compares well with other countries and the regular rate will reach 25% by 2010. As always, consult experienced legal and tax advisers in each country. leon.harris@il.ey.com, sigal.griba@il.ey.com Leon Harris is an International Tax partner at Ernst & Young Israel. Sigal Griba is a Tax Incentives Leader at Ernst & Young Israel.