We are pleased to share with you an important update regarding tax breaks for technology companies in Israel.
1. General Background
Last week, a draft government decision was published as part of the Economic Plan for the years 2017 and 2018 aimed at encouraging the activities of intellectual property, or IP, based high-tech companies and increasing the attractiveness of the Israeli economy for investment by foreign companies.
The background to this proposed decision lies on one hand, with the OECD’s policy, which was recently published as part of the BEPS project and is aimed at taxation of IP income by the country in which the income-generating activities took place, rather than cost plus arrangements which are currently used, and on the other hand, with legislative initiatives of various countries such as Ireland, that aim to create a favorable climate for IP-based activities to attract companies in light of such new policy. The goal is to seize the opportunity which has been created due to the change in the OECD’s policy regarding the taxation of IP income based on the location in which value is produced, while offering an attractive tax regime that constitutes a true alternative to tax regimes in countries that encourage technology-based activities.
2. The Preference Tax Tracks
Tax preference tax tracks would enter into force starting January 1, 2017.
Following is an overview of the preference tax tracks. This overview is general in nature due to the level of details included in the proposed decision and the fact that these may undergo several changes as part of the legislation process.
2.1 Preferred Technology Enterprise
- Preferred Technology Enterprise: Eligibility for this status will be regulated by a “green track” for an enterprise that meets certain conditions (indicating, among other things, research and development, or R&D activities) or alternatively by way of approval of the National Authority for Technological Innovation with the consent of the Israel Tax Authority in accordance with criteria to be determined. In addition, the Preferred Technology Enterprise must meet an export condition of at least 25% of the sales of such enterprise.
- Tax breaks: a corporate tax rate of 12% for preferred technology-based income, which is essentially income from IP-based activities, and a 4% tax rate on dividend distributions out of such income to a foreign resident parent company (or a lower rate under a tax treaty).
- It should be emphasized that the sale of R&D services (for example, cost plus arrangements) exceeding 15% of the enterprise's income will not be considered technology-based income.
2.2 Special Preferred Technology Enterprise
- A Special Preferred Technology Enterprise is an enterprise that meets all of the conditions of a Preferred Technology Enterprise and, in addition, the total annual revenue of such enterprise together with other companies in the group is NIS 10 billion or more.
- Tax breaks: a corporate tax rate of 6% for preferred technology-based income and capital gains from the sale of certain IP rights to a related party, and a 4% tax rate on dividend distributions out of such income to a foreign resident parent company (or a lower rate under a tax treaty).
2.3 Special Preferred Enterprise for Large Global Companies – More Flexible Conditions
- General: A Special Preferred Enterprise is entitled to a reduced corporate tax rate of 5% in Development Area A and a rate of 8% in the rest of the country with respect to all preferred income for a period of 10 years. A Special Preferred Enterprise is required to obtain approval from a number of government agencies on the basis of a business plan that shows that the enterprise will contribute substantially to economic activity. The business plan must meet one of the following alternatives: Investment in productive assets, investment in R&D or employment of new employees. The conditions that an enterprise must meet each year to be considered a Special Preferred Enterprise include a requirement that such enterprise have preferred income of NIS 1.5 billion, and total income of the Preferred Company together with other companies in the group of NIS 20 billion.
- The strict eligibility criteria for Special Preferred Enterprise status resulted in only one company – Intel, benefiting from such status.
- The draft decision provides relief in connection with the various conditions related to this track, including:
- Reduction of the preferred income threshold required from NIS 1.5 billion to NIS 1 billion per year;
- Reduction of the total income threshold required by a Preferred Company from NIS 20 billion to NIS 10 billion per year;
- Greater flexibility with respect to the conditions of the investment in R&D alternative in the business plan;
- A reduced tax rate on dividend distributions of 5% as a temporary measure for three years, for dividends distributed to a foreign parent company.
It should be emphasized that we are dealing at this stage with draft proposals for government decisions, and there is yet a long path until the changes proposed in the draft decision are adopted. We will continue to monitor developments in this area and update accordingly. We will be happy to answer any question or clarification on this matter.