Tax breaks for service platforms in Israel

US tax form (illustrative) (photo credit: INGIMAGE)
US tax form (illustrative)
(photo credit: INGIMAGE)
The Israel Tax Authority (ITA) has just issued a general tax ruling allowing a Platform as a Service (PaaS) operation to enjoy super-low tax rates as a Preferred Technological Enterprise (PTE) on its profits (Ruling 4668/20). This makes the Start-Up Nation even more attractive for techies and investors. This beats offshore islands and patent-box regimes in some other countries. All that’s missing are the jeans and sneakers.
What is a PTE?
A PTE enjoys company tax rates of 7.5% in development area A and 12% elsewhere in Israel on preferred technological income from preferred intellectual property (IP).
Dividends are taxed at 20% subject to any tax treaty, but only 4% if paid directly to a 90% foreign corporate shareholder out of post-acquisition profits.
There are no time limits so long as you comply.
Briefly, a PTE is an enterprise that belongs to an Israeli resident company and meets a number of conditions including the following:
• R&D: R&D in the three preceding tax years (or from formation if less) averaged at least 7% of revenues or NIS 75 million per year from unrelated parties or related parties approved by the ITA;
• Employees/revenues/funding: 20% of employees or 200 employees engaged on R&D OR a venture capital fund invested NIS 8 million, or revenues grew on average 25% in the three preceding years and exceeded NIS 10 million in each of those years, or the number of employees grew on average 25% or more in the preceding three years and there were at least 50 employees in each of those years.
• Innovation Authority approval: Alternatively to the above, the Innovation Authority confirms the enterprise is innovative having regard to the use of advanced technology and privileged IP;
• Group size: Group revenues are below NIS 10 million;
• Competitive/exporter: At least 25% of income from sales to a market with a population of at least 14 million, or sales to any one market not more than 75% of total sales, or main activity is bio- or nano-technology per the Innovation Authority
• Preferred IP: This refers to an Israeli patent, software program, copyright, plant gene, other asset prescribed by the finance minister or knowhow approved by the Innovation Authority.
• Technological income: This is essentially income from one of the following: giving a right to use preferred IP; service based on preferred IP; product produced with preferred IP; products or services ancillary to the above; R&D service income not exceeding 15% of revenues; anything else approved by the finance minister; but not: income from marketing intangibles, production income (separate benefits may apply).
• Preferred technological income: This is technological income, as above, which is derived from R&D in Israel per nexus regulations intended to meet OECD nexus rules against BEPS – base erosion and profit shifting (KT 7825, June 14, 2017).
TAX RULING for PaaS:
In this ruling, an Israeli resident company provides PaaS services to clients via a cloud-based platform using IP and software it develops and owns. The services include storage, back-up, disaster recovery (DR), checking the system works, data security, efficient management, smart resource allocation, user portal, etc. Income is from giving customers the right to use the software and related services on the platform in the cloud.
The ITA ruling says this amounts to a technological income of a PTE eligible for tax breaks if all the conditions in the small print of the tax law (Law for the Encouragement of Capital Investments) are met. But the tax breaks don’t apply if customers don’t get software usage rights as well as a service.
Implications:
The ruling is anonymous, meaning other taxpayers in a similar situation may assume it is applicable to them. Earlier ITA rulings also granted PTE tax breaks for SaaS.
Typically in the first few years, many hi-tech operations make losses that can be utilized before enjoying the low PTE rates. And if there is an exit – share sale e.g. via M&A, or after an IPO – then foreign investors should be exempt from Israeli capital gains tax and only pay tax in their home country. Israeli resident investors and founders may pay Israeli capital gains tax of up to 33%.
What’s the catch? US investors should check if they face a US GILTI tax liability. Consult your US CPA.
As always, consult experienced tax advisers in each country at an early stage in specific cases. The writer is a certified public accountant and tax specialist at Harris Horoviz Consulting & Tax Ltd. [email protected]