Your taxes: Israeli tax ruling for tech companies solves OECD issues

Dividends are taxed at rates ranging from 25% to 32%, resulting in a combined tax burden on distributed corporate profits of 45%-50%.

Shekel money bills (photo credit: REUTERS)
Shekel money bills
(photo credit: REUTERS)
The Israel Tax Authority has just published a tax ruling showing how software companies can qualify for preferred enterprise tax breaks (Ruling 6827/14). It could be very beneficial to multinational tech groups.
Regular Israeli corporate tax rates
The standard rate of company tax in Israel in 2014 is 26.5 percent.
Dividends are taxed at rates ranging from 25% to 32%, resulting in a combined tax burden on distributed corporate profits of 45%-50%. This is subject to any tax treaty in the case of foreign companies and investors.
Israeli corporate tax breaks
Preferred enterprises that derive preferred income from an industrial enterprise (including tech) in Israel pay company tax of 9% in development area A and 16% elsewhere, if they are in biotech or nanotech or their exports amount to 25% of sales.
The withholding tax on their dividends is 20%. This is according to the Law for the Encouragement of Capital investments, 1959.
The resulting combined tax burden on distributed tax break profits is therefore 27.2%-32.8% subject to any tax treaty in the case of foreign investors.
Applicability to tech companies
The above ruling discusses an Israeli resident company engaged in developing software that serves as a platform that connects suppliers of websites or software who are willing to display ads of customers who want to advertise their products online.
Customers pay the company per click or impression for the use of the relevant software.
Suppliers pay the company a commission for the use of the relevant software.
Aside from software development, the company employs people to provide services; namely, to operate the software for suppliers and customers in an optimal way for them.
This is to maximize ad-campaign expenditures, encourage new campaigns, match ads to suppliers and so forth.

What the ruling says

The ruling determined that the company has an industrial enterprise and a preferred enterprise for the purposes of the Law for the Encouragement of Capital Investments. As such, income from suppliers and customers for the use of the relevant software is preferred income that qualifies for the above preferred enterprise tax breaks.
However, income from the above services is not preferred income and is taxable at regular Israeli tax rates.
The split between the two types of income, preferred and not preferred, is according to a formula based on the split of salaries of service employees to total employees engaged in development activities.
Comments
This ruling will be of great interest to many multinational tech concerns. Recently the OECD has proposed rules against so-called “Base Erosion Profit Shifting” (BEPS). These proposals say that digital enterprises should allocate profit to wherever value is generated by people, not to offshore shell companies that merely own intellectual property.
This Israeli tax ruling fits in remarkably well with the OECD proposals by generating value in Israel using Israeli engineers and paying low Israeli taxes. It seems the “preferred enterprise” tax breaks in Israel have a bright future.
As always, consult experienced tax advisers in each country at an early stage in specific cases.
leon@hcat.co Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.