Israel grants extensive tax breaks for "privileged enterprises" and "approved enterprises" in industry, hi-tech and life sciences.
These breaks provide for:
* Corporate tax rates range from 0% (yes, zero tax, for undistributed profits) to 25% for a period of benefits ranging from two to 15 years (depending mainly on location within Israel);
* Reduced dividend withholding tax rates of 4%-15% also apply.
The main conditions are that the enterprise invests at least NIS 300,000 in productive fixed assets and derives at least 25% of its revenue from overseas markets (the latter is not necessary in the bio or nano tech fields). Approved enterprises cannot enjoy 0% tax (unless they are located in development area A) but they may receive fixed asset grants of 10% - 24% if they are located in a development area.
If you want to enjoy the tax break again, you can expand the enterprise into a "mixed enterprise." It is necessary to meet the above conditions and increase the investment in productive fixed assets by 12% (less if your investment exceeds NIS 140 million) or NIS 300,000, whichever is higher.
The tax breaks of a mixed enterprise are then split between the old and new enterprise(s) based on the resulting increase in revenues.
So if annual revenues increase from NIS 10m. to NIS 15m., one-third of profits (NIS 5m./NIS 15m.) will be allocated to the new enterprise when calculating the tax breaks. This calculation is repeated annually.
On August 6, 2007, new regulations were passed that introduce an obsolescence factor to reduce the base revenues of a mixed enterprise by 10% per year, i.e. from NIS 10m. in the above example to NIS 9m. after one year, NIS 8m. after two years, and so forth. This increases the tax breaks given to the newer part of the mixed enterprise.
The annual 10% obsolescence factor is intended for technology companies. Therefore, certain conditions must be met regarding, in particular:
(1) Research and development expenditure amount to at least 7% of revenues in the same year or the same year plus the previous year
(2) At least 20% of the employees have academic degrees in engineering, computers, natural sciences, or exact sciences (mathematics, physics, etc) and work in the field they studied; in the same year or the same year plus the previous year
(3) A material change occurs in the product range (50% of revenues) and/or the means of production (50% - 100%), calculated according to detailed rules.
Most important, these new regulations have retroactive effect to 2004 for "privileged enterprises" and 2005 for "approved enterprises" and transitional rules have been prescribed.
If an approved enterprise expanded its operation in 2004 or before ("year of operation") and obtained a ruling for erosion of the base revenues, it may apply the new regulations in 2005 even if it does not meet condition (3) above.
So if you have a "mixed enterprise" or are planning a plant expansion, please check whether you just became eligible for better tax breaks for past and future years.
Wishing all our readers a very happy, healthy and prosperous New Year.
Leon Harris is an International Tax partner at Ernst & Young Israel. Sigal Griba is a Tax Incentives Leader at Ernst & Young Israel.