Your Taxes: Business tax breaks - have your say

A recap of Israeli tax breaks, together with some views and ideas, to start the ball rolling.

By LEON HARRIS
As discussed in last week’s column, the Israeli government wants your views and ideas regarding the present Israeli tax breaks under the Law for the Encouragement of Capital Investments. Here is a recap of the tax breaks, together with some views and ideas, to start the ball rolling.
Current crop of tax breaks
In brief, the main Israeli tax breaks in the law for “privileged enterprises” and “approved enterprises” in industry and tourism are as follows:
• Main Green Channel Package: Zero company tax for retained profits. If and when profits are distributed as dividends, the company tax rate will range from 10 percent (if foreign ownership is 90% or more) to 25% (if foreign ownership is below 49%). In addition, there will be a 15% dividend withholding tax. The combined Israeli taxes on distributed profits will, therefore, be 23.5% to 36.25%.
The company tax benefit period is 10 years in Development Area A. Elsewhere in Israel, the benefit period is seven years, but a 10-year period is granted to a Foreign Investors’ Company in which foreign residents have invested NIS 5 million.
• Ireland Package: So called because the corporate tax rate can be lower than in Ireland, home to many hi-tech plants. In Development Area A, it is possible to elect 11.5% company tax on retained and distributed profits for 10 years. If profits are distributed to foreign-resident shareholders, a 4% dividend withholding tax rate applies, resulting in total Israeli taxes on distributed profits of 15.04%. A 15% dividend withholding tax rate applies to Israeli resident shareholders, resulting in total Israeli taxes on distributed profits of 24.8%.
• Large/Strategic Investor Package: Large investments (NIS 600m. to NIS 900m.) in privileged enterprises by large groups in certain areas of Israel may qualify for zero company tax for both retained and distributed profits as well as exemption from dividend withholding tax. The benefit period is seven to 10 years. This package is for groups with annual revenues exceeding NIS 13 billion to NIS 20b.
• Foreign Intensive Investment Company: Such companies enjoy an extra five years of company tax benefit under their selected package; i.e., up to 15 years instead of 10. This applies to an industrial company where the level of foreign ownership exceeds 74% and at least $20m. is invested in an industrial enterprise. In the last five years of benefit, the company must derive at least 80% of revenues in foreign currency.
• Fixed-asset grants for an approved enterprise: If fixed-asset grants are desired, there is a grant plus low-tax package for an approved enterprise. The grants range up to 32%, depending on location, and company tax rates range from 10% to 25% for seven to 15 years. If profits are distributed, there is a 15% dividend withholding tax. The resulting combined Israeli taxes on distributed profits may range from 23.5% to 36.25%.
What’s wrong with these tax breaks?
Actually, nothing. The tax breaks have helped to attract many billions of dollars of investment capital into the Israeli economy over the last half century. Every few years the tax breaks are tweaked and improved. Of course, tax isn’t everything. What also helps is the Israeli innovative streak, grants for research and development (typically 50%) and skilled labor.
For the next round of improvements, how about the following:
• Improve the tax rates: The present rate of company tax for privileged and improved enterprises can be as low as zero on undistributed profits. On distributed profits, the company tax rates range up to 25%, which happens to now be the regular rate of company tax for all Israeli companies.
In the international arena, the benchmark is Ireland, which offers a 12.5% tax rate for manufacturing operations of all types. If Israel is to remain attractive tax-wise, it needs to match or beat the Irish rate.
• Simplify the qualifying activities: At present there are detailed definitions governing productive enterprises (and hotels/tourism) that qualify for the tax break. In a hi-tech and clean-tech era where technologies are generated and exploited, and software is duplicated by pressing a keyboard on a laptop, there is no longer a clear boundary between production and service.
Therefore, anything that generates added value should be rewarded, not only productive enterprises. Added value is easily calculated on monthly VAT returns as revenues minus purchases. Alternatively, it can be calculated as profit plus salaries. So let’s find a formula that encourages both with lower tax rates.
• Fixed-asset purchase rule: Currently, one of the conditions for getting “privileged enterprise” status is the need to invest NIS 330,979 (in 2009) in productive fixed assets. This is nearly impossible for start-ups at a time when the average PC and basic software package sells for only NIS 5,000 to NIS 10,000 and so does a basic telephone system.
A start-up with a handful of personnel does not need 33 to 66 computers and phone systems. Some companies may need some other equipment, but only in certain limited fields. The main cost for hi-tech, bio-tech and clean-tech is usually salaries. So the fixed-asset purchase rule needs to be scrapped.
• Reform the Industrial R&D Law ownership rules: A bone of contention among multinational groups concerns R&D grants. In order to receive a grant, a company must agree to retain ownership of the resulting technology in Israel. This gets very problematic if you want to develop later generations of that technology somewhere else (e.g., in California); is that a crime under Israeli law?
Moore’s Law states that chip-data density doubles every 18 months approximately. Gordon Moore was a cofounder of Intel. Consequently, much technology was developed over many generations in many places by many people. So a technology sale agreement is getting rare; instead, modern tech agreements usually only grant permanent rights of usage, because that’s all they can grant.
Therefore, to help encourage R&D investment in Israel, the Israeli ownership rule needs to be scrapped. This is not a tax matter, but the issue is on nearly every tech company’s agenda.
• Rental buildings: In addition to the above, there are tax breaks for rental buildings that dedicate at least half of their floor space to residential rentals for five to 10 years. The other half can be used as shops, offices, etc.
In practice, rental yields are very modest in Israel and so there are few such rental building projects, and residential leases in Israel are typically annual with a one-year renewal option for the tenant. Therefore, to encourage cheaper rental housing, the minimum rental period needs to be reduced to one to two years.
• Foreign residents’ real-estate association: To further encourage residential projects, special rules in the law grant acquisition tax and land appreciation tax benefits to entities with at least 50 foreign residents that undertake to build and sell or rent at least 50 homes.
In practice, the uptake on this incentive is close to zero because: (1)active builders generally pay income/company tax, not land appreciationtax; (2) if the investment is offered to 35 or more investors, apublic-listing prospectus may be needed under the Securities Law; and(3) what about Israeli investors?
The above recommendations have been forwarded to the relevant Israeli government officials. Do you have any more comments?
As always, consult experienced tax advisors in each country at an early stage in specific cases.
leon.hcat@gmail.com
Leon Harris is an international tax specialist at Harris Consulting & Tax Ltd. and Western Fiduciary Ltd.