The new tax incentives for Israeli hi-tech - opinion

The prime minister and the finance and innovation ministers announced on October 20, 2021, plans to enhance the tax incentives for hi-tech companies and others.

Calculating taxes (photo credit: INGIMAGE)
Calculating taxes
(photo credit: INGIMAGE)

The prime minister and the finance and innovation ministers announced on October 20, 2021, plans to enhance the tax incentives for hi-tech companies and others:

Tax write-offs for angel investors; Tax write-offs for M&A; No tax for foreign financial lenders.

Tax write-off for angels

The first proposal is to bring back the “Angels Law” which expired a few years ago. The intention is to reward investors in private companies with an Israeli tax write-off for angel investors in start-ups at the seed and pre-seed stages if certain conditions are met. Unfortunately, those conditions are not spelled out yet, except an indication that investments up to NIS 3.5 million may be covered. Alternatively, individual investors may get a capital gains tax deferral if they sell and reinvest in a start-up. The old Angels Law in Israel never took off because it suffered from a string of bureaucratic conditions. By contrast, the EIS (Enterprise Investment Scheme) successfully applies similar principles in a pragmatic way in the UK and London, among others promoting angel investment groups.

How are Israeli start-ups financed? Currently, venture capital funds are pumping money into Israeli start-ups at the rate of billions of dollars a year without getting a tax write-off. Instead, they discipline risky private companies to reduce those risks by laying down and adhering to business plans, often with ambitious technological and marketing goals. Furthermore, foreign angel investors may not have other taxable income in Israel against which they can deduct the tax write-off.

If the proposed new “Angels Law” in Israel contains too many bureaucratic conditions, we predict it may suffer the same fate as the old one.

Tax write-offs for M&A

The second proposal is to allow a tax write-off for hi-tech companies which acquire other hi-tech companies. This may encourage them to grow by acquisition while leaving activity and intellectual; property (IP) in Israel, or at least in Israeli hands. Again no details are specified.

Comment: a tax write-off may encourage established Israeli tech companies to acquire other tech companies in Israel and abroad, but there are issues to address. Suppose an Israeli company buys all the shares/stock in a US tech company and then liquidates the US company in order to own the IP. Will that liquidation trigger an Israeli or US capital gains tax event? And will this cause unpopularity if personnel are then dismissed?

Alternatively in this example, if the US company is not liquidated, will the Israeli company have to pay ongoing royalties to the US company for the use of its IP, triggering ongoing withholding tax payments of 10%-15% to the US IRS under the Israel-US tax treaty?

In short, it takes two or more countries to tango in cross border M&A.

No Israeli tax for foreign financial lenders

Currently, if Israeli tech and other companies borrow money to finance operations or M&A from a foreign financial institution, that triggers Israeli withholding tax on the interest of 23%-30% unless reduced by a tax treaty. It is proposed “as an incentive” to exempt foreign financial institutions from such tax, but again we have no details yet. In practice, This is more of a commercial necessity if Israeli companies are to have access to foreign loans.

More comments

The above measures are proposals only, it remains to be seen what will be enacted, and when. In practice Israeli tech companies tend to raise money from venture capital (VC) funds or private equity (PE) funds, rather than angel investor individuals or foreign banks.

Such funds usually raise money from many angel investors and add financial expertise and supervision over the investee companies. Some funds even move investee companies into incubators or their own premises, in order to keep an eye on them.

Foreign banks are unlikely to lend to Israeli tech companies because the latter typically lack collateral – tangible fixed assets – to secure loans on. It is difficult to secure loans on the intangible assets (knowhow, etc.) that tech companies typically have. By contrast, VC and PE funds aim to reduce their investment risks by spreading their investments and vigorous due diligence checks on investee companies.

Nevertheless, VC and PE funds typically count on a liquidity event – acquisition or IPO within around 3 years – to make a fast profitable exit. But many in Israel now want to see Israeli companies mature and grow rather than be bought out. The Israeli government’s proposals apparently reflect an attempt to encourage finance for more mature companies. Time will tell.

As always, consult experienced tax advisers in each country at an early stage in specific cases.

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The writer is a certified public accountant and tax specialist at Harris Horoviz Consulting & Tax Ltd.