The amendment comes in the wake of the recent OECD campaign against base erosion and profit shifting (BEPS). By developing intellectual property (IP) in Israel, value is created in Israel and profits may be legitimately attributed to Israel according to OECD principles. Following is a brief overview.
The new Israeli tax breaks:
Commencing in 2017, the “preferred technological taxable income” of a “preferred company” with a “preferred technological enterprise” will be subject to Israeli company tax at rates of:
- 12% generally;
- 7.5% in peripheral areas (referred to as development area A);
- 6% in the case of a “special preferred technological enterprise”.
Dividends after the above tax will be subject to withholding tax at rates of:
- 20% generally, subject to any applicable tax treaty;
- 4% if distributed to a 90%-or-more foreign resident corporate shareholder.
Therefore, the combined Israeli tax burden on distributed tech profits may range from 9.76% to 29.6%.
By contrast, when no tax breaks apply, the standard rate of company tax in Israel is 24% in 2017 and dividends paid to 10%-or-more shareholders are taxed at 30%-33%. This results in an Israeli tax burden on distributed regular profits of up to 49.08%
What is a “preferred company”?
This is a company incorporated in Israel not owned by the State, or partnership of such companies that owns a preferred enterprise, is not transparent for Israeli tax purposes, has a business controlled and managed in Israel, keeps books and files tax returns as required, and neither the company nor its office holders have committed a tax offense in the last ten years.
What is a “preferred technological enterprise”?
This refers to an enterprise which: (1) spent on R&D in the previous three tax years (or since inception) at least 7% of revenues or NIS 75 million per year, AND (2) R&D employees number 200 or account for 20% of salaries OR a venture capital fund invested at least NIS 8 million OR revenues grew 25% annually in the three preceding years and amounted to at least NIS 10 million per year OR the number of employees grew 25% annually in the three preceding years and there were at least 50 employees in each year. Alternatively, this refers to an enterprise approved by the Chief Scientist at the Economic and Industry Ministry, especially industrial enterprises that use privileged IP. Alternatively, this refers to a “competitive enterprise” not part of a group with revenues exceeding NIS 10 billion engaged mainly in biotech or nanotech, or does not derive more than 75% of income from any one market (i.e. country), or derives at least 25% of income from sales to a market of at least 14 million inhabitants, directly or in conjunction with another industrial enterprise.
What is a “special preferred technological enterprise”?
Basically, this refers to a preferred technological enterprise in a group with annual revenues of at least NIS 10 billion
What is “preferred technological taxable income”?
This refers to income from R&D in Israel from a technological enterprise accrued or derived in the ordinary course of it business from “privileged IP” partly or wholly owned or used by the enterprise, including income from any of the following: (1) granting the use of the IP, (2) software-based service, (3) product made using the IP, (4) software support product related to the IP if certain conditions are met, (5) support services relating to the above, (6) sale of R&D services not exceeding 15% of the enterprises’s revenues, (7) anything else the Finance Minister may prescribe.
What is “privileged IP”?
“Privileged IP” refers to rights protected by Israeli or foreign law relating to: patents; software; breeders of growth varieties; or knowhow developed in Israel by a technological enterprise and approved by the National Technological Innovation Authority, or, in the case of renewable energy, by the Chief Scientist of the National Infrastructure Energy and Water Ministry, provided annual revenues in the tax year concerned did not exceed NIS 32 million for the enterprise or NIS 211 million if it is part of a group . Marketing IP is excluded.
In other words, IP of many types may qualify relating to computing, internet, biotech, medical devices, cyber and homeland security and many more, but not brand names.
A sale of privileged IP may qualify for a 6%-12% tax rate on capital gains for IP sold to a foreign affiliate if the enterprise always owned the IP or acquired it from a foreign resident company. Otherwise, regular Israeli tax rates apply.
What about non-technological enterprises?
Traditional industries may enjoy company tax of 7.5% (was 9% pre-2017) in a peripheral area or 16% in other parts of Israel, and dividend withholding tax of 20%, subject to any applicable tax treaty.
Israel is open for high tech low tax business which is OECD-compliant.
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 advisors in each country at an early stage in specific cases.