Transfer of Manufacturing Rights
Transfer of Know-How
Rate of Grant
The Israeli Parliament is reforming the Law for the Promotion of Industrial Research and Development 1984. Under the current law, Israeli IT firms can receive cash grants for research and development (R&D) projects which increase Israeli production and exports and create jobs in the IT industry. The grants are issued by the Office of the Chief Scientist (OCS) which is part of the Ministry of Industry and Trade.
The law is being amended at the recommendation of the Ministry of Finance and the Ministry of Industry and Trade, as well as the Prime Minister's Office, to reflect the increasing globalization of trade and recent developments in the domestic IT industry.
The main proposed changes are outlined below.
Section 1 of the current law outlines its main objectives as encouraging the development and creation of jobs in Israel's IT industry and promoting the production and exportation of goods. The proposed amendment presents a new objective of encouraging industrial R&D that will substantially benefit the Israeli market. This amendment reflects the economic theory that R&D investment impacts positively on the national economy beyond the benefits enjoyed by individual companies.
Transfer of Manufacturing Rights
One of the current law's more onerous provisions is Section 19, which requires that products developed using OCS grants must be manufactured solely in Israel. However, the OCS has discretion to allow the transfer of manufacturing outside Israel (but subject to a higher rate of royalties payable to the state). Specifically, regulations issued under the law provide for the following increases in the regular royalty rate for overseas manufacturing:
- 120% of regular royalties where up to 50% of production occurs outside Israel;
- 150% of regular royalties where between 50% and 90% of production occurs outside Israel; and
- up to 300% of regular royalties where more than 90% of production occurs outside Israel.
The proposed amendment will allow (but not encourage) the transfer of both know-how and manufacturing rights abroad under clearly defined conditions, including considerations of manufacturing costs. Companies that request a grant must commit to maintaining a certain rate of manufacturing in Israel. A company which does this and receives an OCS grant will be entitled to diverge from such commitment subject to certain conditions as follows:
- Permission is not required from the OCS's Research Committee for the transfer abroad of up to 10% of manufacturing but not know-how (although a statement must be submitted from the company's chief executive officer 60 days in advance).
- Permission must be obtained from the OCS's Research Committee for the transfer abroad of more than 10% of manufacturing. The committee may demand state compensation of up to 120% of the grant, including interest and increases reflecting the rise in the CPI, from the date when the grant was approved. This is payable in a single lump sum. Again, this provision does not include the transfer of know-how.
- A transfer of know-how is subject to the compensation structure discussed below.
Full-scale manufacturing in Israel will not be a condition for receiving a grant, but a company declaring its intention to manufacture in Israel will be given preference in terms of approval and size of the grant.
Under Section 19 of the current law, knowledge acquired and technology developed with OCS grants may not be transferred abroad. However, the Research Committee may approve the transfer of know-how within Israel to another individual or company, on condition that the transferee is subject to the same transfer restrictions as the transferor.
The proposed amendments permit the transfer abroad by an Israeli transferee of know-how developed with OCS grants, subject to (i) the original grant recipient receiving an exclusive and unlimited licence to use the know-how, and (ii) cash compensation being paid to the state at the higher of the two following amounts.
The first amount is the company's current market value (on the date when the Research Committee approved the transfer), multiplied by the ratio of the amount of OCS grants (also on the date of approval) to other investments in the company. A 20% premium will be added to the compensation amount, less royalties already paid.
The second amount is 150% of the total grants granted by the OCS to the company which received approval, plus interest and increases reflecting the rise in the CPI.
Under Section 28 of the current law, the grant amount is calculated as a part of R&D expenses. Generally, the grant amount is fixed at a rate of 50% of a company's R&D expenses for developing a new product, except in the case of improvement of a military or civilian product (20% and 30% respectively), or in the case of a start-up company (66%).
Under the proposed amendments, the grant will range from between 20% and 50% of R&D expenses. However, the rate will be determined by taking into consideration only the substantial benefit of the requested programme to the Israeli market.
Under Section 23 of the current law, a company may appeal a decision of the Research Committee by filing an objection within 45 days of receipt.
Under the proposed amendments, the Research Committee will hold a new procedure of further hearing within 30 days of a request by a company which is unhappy with a committee decision. Applying for a further hearing is subject to a fee payment of IS5,000. The Research Committee's second decision can be appealed before an administrative court within 30 days of being delivered.
The proposed amendments add Section 29(b) to the law, according to which a 'first charge' or lien in favour of the state will apply to all payments that it should have received in respect of the OCS grant. Thus, where a company enters into liquidation or receivership, neither its know-how nor its manufacturing rights can be sold until all payments owed to the state are settled.
The proposed amendments reflect the philosophy that a balance should be maintained between openness to globalization and developing a modern marketplace that will encourage business in Israel on the one hand, and protection of accumulated IT knowledge and technology developed with the help of OCS grants on the other.
For further information on this topic please contact Joel Stein or Tal Govrin at Eitan, Pearl, Latzer & Cohen-Zedek by telephone (+972 9 970 9000) or by fax (+972 9 9709001) or by email ([email protected]).
An earlier version of this article first appeared on the Eitan, Pearl, Latzer & Cohen-Zedek website.