Your Taxes: How will the Trump tax reform affect Israel?

We believe the proposed 15% US federal tax rate may deter US businesses from moving out the US. It may not be enough to make Israeli businesses uproot to the US.

money (photo credit: REUTERS)
(photo credit: REUTERS)
US Treasury Secretary Steven Mnuchin and US National Economic Director Gary Cohn unveiled the Trump administration’s tax reform proposal last Wednesday. It was a single page with bullet points headed: “The Biggest Individual And Business Tax Cut In American History.” Here’s what the Trump reform proposal says.
Goals for tax reform: Grow the economy and create millions of jobs; simplify our burdensome tax code; provide tax relief to American families – especially middle-income families; lower the business tax rate from one of the highest in the world to one of the lowest.
Individual reform: Tax relief for American families, especially middle-income families; reduce the seven tax brackets to three tax brackets of 10%, 25% and 35%; double the standard deduction; provide tax relief for families with child- and dependent-care expenses.
Simplification: Eliminate targeted tax breaks that mainly benefit the wealthiest taxpayers; protect the home-ownership and charitable-gift tax deductions; repeal the alternative minimum tax; repeal the death tax; repeal the 3.8% Obamacare tax that hits small businesses and investment income.
Business reform: 15% business tax rate; territorial tax system to level the playing field for American companies; one-time tax on trillions of dollars held overseas; eliminate tax breaks for special interests.
Process: Throughout the month of May, the Trump administration will hold listening sessions with stakeholders to receive their input, and it will continue working with the House and Senate to develop the details of a plan that provides massive tax relief, creates jobs, makes America more competitive – and can pass both chambers.
How does Israel compare?
Salaries and business profits of freelancers are subject to income tax in Israel at rates ranging up to 50%. There is no “death tax” in Israel.
For 2017, the regular Israeli company tax rate is 24%. The regular dividend tax rate is 30%-33% for 10%-or-more shareholders and 25%-28% for other shareholders, resulting in a combined tax burden on distributed corporate profits of 43%-49.08% subject to any tax treaty in the case of foreign investors.
Preferred income derived by preferred industrial and tech enterprises is liable to Israeli company tax of 6%-9% in development area A and 12%-16% elsewhere in Israel without a time limit. Dividends are taxed at 4 %-20%. The resulting combined tax burden on distributed profits is 9.76%-32.8% subject to any tax treaty.
There are also tax breaks for: capital gains of foreign-resident investors, agriculture, approved rental buildings and movie productions. R&D grants typically range up to 50%.
Will Israeli business shift or drift to the US? It remains to be seen whether the US will enact the above measures.
Some think that if the US enacts the 15% business tax rate, this will act as a magnet and draw in business from Israel and other countries to the US. This is speculative. It may also be missing the big picture.
Many US groups have set up supply chains that leave US profits to be taxed in the US and shift non-US profits into offshore locations. Other US groups have inverted themselves into non-US groups for similar tax reasons.
But it seems Israeli tech other industrial operations will prefer to stay put in Israel. Most start-ups generate losses in their development period in their first few years and spend the next few years utilizing those losses against initial profits.
Afterward, a successful Israeli start-up may perhaps make an “exit” and get sold for a capital gain. If so, the shareholders pay capital-gains tax of 33% if they are Israeli residents or 0% typically if they are foreign residents.
If there is no exit, the Israeli tax rates above for “preferred enterprises” are comparable or better than the proposed 15% tax rate for US businesses.
There are various conditions to be met for a preferred enterprise that sometimes require getting official approval – but not always. And getting the Israeli Innovation Authority’s approval for a tech operation may not be too arduous unless you think that sandal making is technological. Failing that, exports of 25% of revenues are needed, and you know if you met that from the monthly VAT returns.
Suppose you are in an Israeli no-tech business, such as wholesale, retail, real estate or services? In such a case, it may be physically impossible to move it to the US. Even if you can move the business, partly or wholly, there are other aspects to consider, such as US state and local taxes on top of the 15% US federal tax. Furthermore, there are transfer-pricing rules if there is a split US-Israeli operation and Israeli capital-gains tax and/or royalty withholding tax if the operation or its know-how or goodwill are shifted to the US.
To sum up: We believe the proposed 15% US federal tax rate may deter US businesses from moving out the US. It may not be enough to make Israeli businesses uproot to the US.
Furthermore, the “Start-up Nation” is said to offer one other big advantage over other countries: better innovation skills due to the Israeli can-do mentality (and chutzpah).
As always, consult experienced tax advisers in each country at an early stage in specific cases.
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Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.