Amendments to the Encouragement of Capital Investment Law, 5719-1959 (“Encouragement of Investment Law”) will provide significant tax benefits to IP-based companies operating in Israel and new instructions published by the Israel Innovation Authority[1] will remove some of the regulatory obstacles that Israeli startups financed by government funding encounter when commercially cooperating with foreign entities.

Encouragement of Capital Investment Law

According to the amended Encouragement of Investment Law, tax benefits will apply to income generated from sales of IP-based products and services and specifically to the part of such income which can be attributed to research and development activity that took place in Israel.

Depending on the criteria met by the company, corporate tax rates will be reduced to 6%, 7.5% or 12%, the capital gains tax rate will be reduced to 6% or 12% and dividend tax rates will be reduced to as low as 4%. Such criteria include the company’s yearly revenue and the location in which the R&D activity took place in Israel; criteria for a company’s eligibility to receive the new tax benefits were also alleviated.

The background to the amendment to the Encouragement of Investment Law is the release of the BEPS (Base Erosion and Profit Shifting) package by the OECD in October 2015, the government acknowledgment of the significance of the high-tech industry to the Israeli market and conclusions of a team led by the Director General of the Ministry of Finance that highlighted the fact that the Encouragement of Investment Law in its previous format proved to be non-effective.

The amendment to the Encouragement of Investment Law encourages companies to expand their research and development activity in Israel by introducing tax benefits specifically designed for the unique activity of IP-based companies in the high-tech industry, including tax benefits on income generated from IP owned by an Israeli company, such as patents, software, plant breeders’ rights and others, as well as non-registered IP. The wording of the amended law is broad, so tax benefits can also be applied to income generated from licenses and sale of software as a service (SaaS) and similar “cloud” based services. Tax benefits will also apply to income generated from complementary services, such as technical support, implementation, training and the like and from products accompanying the IP-based product in question.

In order to enjoy the new tax benefits, the IP in question may be fully or partially owned by an Israeli entity or if the Israeli entity has a license to use it. The part of IP to which the income the tax benefits apply will be calculated based on the Nexus formula.

The Israel Innovation Authority

Concurrent with the amendment to the Encouragement of Investment law, the Israel Innovation Authority published new, more lenient instructions regarding use of knowledge that was developed with government funding.

One of the main changes brought about by the new instructions is the possibility for an Israeli startup to grant licenses to entities in foreign countries to use knowledge that was developed in Israel in the framework of a startup financed by the Israel Innovation Authority. In addition, the rate of royalties to be paid to the government from income generated in connection with such knowledge was reduced.

In Conclusion

The shared goal of the aforementioned amendments to legislation and changes in policy is to assist in the globalization of the high-tech industry in Israel. Hopefully, these goals will be achieved.