On December 8, 2014, after years of debate and necessity, the Finance Committee of the Knesset (the Israeli parliament) was finally poised to approve the Regulations for the Encouragement of Research and Development in Industry (Permission to Use Know-How Outside of Israel), 5774-2014 (the "Proposed Regulations") which would have permitted licensing of know-how developed with funds from the Office of the Chief Scientist (the “OCS”). As fate would have it, the Knesset voted to disperse the very same morning with the unfortunate effect that the Proposed Regulations were not discussed; their approval, it seems, will have to wait at least until after the March 2015 elections. The Proposed Regulations would have permitted, for the first time, the grant to non-Israelis of rights to use OCS-funded know-how, including grants of R&D licenses, subject to the OCS approval and certain payment and reporting obligations. The Proposed Regulations, when hopefully enacted, will have an effect on many M&A, investment and commercial transactions which involve OCS-funded companies or companies that hold OCSfunded know-how. The Proposed Regulations will also enable companies to reexamine the structure of their operations in order to share their know-how with non-Israeli partners or group companies. Increasing the possibility to exploit OCS-funded know-how through licensing will remove an impediment that has clouded OCS-funded companies in M&A, investment, and technological and commercial cooperation, and at the same time will make OCS funding more attractive to Israeli companies. It is highly recommended to consider the implications of the Proposed Regulations, both regarding future transactions as well as regarding restructuring possibilities of on-going operation of OCS-funded companies. Also note that the Proposed Regulations may bear various tax implications that need to be carefully considered. Should you require any further information or clarification regarding the issues discussed in this circular, please do not hesitate to contact us. E-mail Phone Number Ofer Granot, Tax and Government Incentives email@example.com +972 - 3 - 6922861 OCS, Hi-Tech, M&A and Tax 2 General Israeli companies that receive funding from the Office of the Chief Scientist of the Israeli Ministry of Economy ("OCS") are subject to the provisions of the Law for Encouragement of Research and Development in Industry 5744-1984 (the "R&D Law"). The R&D Law prohibits the transfer abroad or the grant to non-Israelis of rights in know-how that is connected, directly or indirectly, with OCS-funding, unless the OCS approves otherwise and subject to certain payments to the OCS. Currently, it is possible to transfer OCS-funded know-how abroad only by way of sale of the knowhow or through limited types of licenses (such as manufacturing, integration, maintenance and support). As a general matter, it is not possible to grant non-Israelis any other licenses in OCSfunded know-how, including R&D licenses. The Proposed Regulations are aimed to enable the grant to non-Israelis of any right to use OCSfunded know-how ("Rights"), including grants of R&D licenses, subject to OCS approval and certain payments and reporting obligations. This below summary is based on the current version of the Proposed Regulations, which may be changed by the time of their enactment. The OCS Approval The OCS may approve any grant of Rights to non-Israelis. The Proposed Regulations set no limitations on the kind of Rights the OCS may approve and do not require any special circumstances or justifications in order to approve a grant of Rights; the grant does not have to be in the context of an acquisition or other structural change. The OCS may require guarantees from the company or from the licensee for the payment of fees to the OCS required as a condition to the approval of the Rights. Sale of OCS-funded know-how or the grant of manufacturing licenses to non-Israelis will continue to be subject to the rules that currently exist. Each grant of Rights, even if regarding the same know-how approved in the past, is subject to the Regulations (i.e., it will require OCS approval and payment of fees to the OCS). The OCS may update its approval for a grant of Rights if the company receives new funding for a project whose know-how was included in a grant of Rights previously approved by the OCS. OCS approval for a grant of Rights or full payment of the fees to the OCS does not release the company from the rules of the OCS. The company will continue to be subject to the limitations and obligations under the R&D Law, including royalty payment obligation (if applicable) and limitations on transfer of know-how unless it sells its OCS-funded know-how to others in an approved transaction. OCS Fees As a condition to receiving the OCS approval for a grant of Rights, the OCS-funded company will be required to make certain payments to the OCS as detailed below.3 The minimum amount – will be no less than the relevant OCS funding that had been received (including interest). The maximum amount – will be no more than 6 times the relevant OCS funding that had been received (including interest), if the maximum amount is not already fully depreciated. Past royalties paid by the company to the OCS and previous payments paid to the OCS for other grants of Rights regarding the same know-how will be set off from the fees charged. There are no refunds for fees paid if the grant of Rights or the conditions thereof are cancelled or changed. Calculation of OCS Fees - The Total Transaction Amount OCS Fees Paid in one installment The Repayment Amount subject to Depreciation. Paid in installments – two options: Where Repayment Amount > OCS funding, including interest OCS Participation Ratio X Any payment for grant of Rights Where Repayment Amount ≤ OCS funding, including interest Minimal Ratio X Any payment for the grant of Rights Total Transaction Amount = The total payments the OCS-funded company is expected to receive, directly or indirectly, for the grant of the Rights, as determined by the OCS. If the consideration for the Rights is not monetary or fixed, if there are "special relations" between the parties or if the consideration is not arm's length – the OCS may (usually interpreted as "must") determine the Transaction Amount based on an Economic opinion. Repayment Amount = OCS Participation Ratio X Total Transaction Amount Depreciation = The amount is depreciated over 7 years, down to the amount of the OCS funding received (including interest), starting at the end of the third year from the completion of the relevant OCS-funded project. Minimal Ratio = OCS funding including interest Total Transaction Amount OCS Participation Ratio = The OCS funding under the relevant projects R𝐷 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠 𝑜𝑓 𝑡ℎ𝑒 𝑐𝑜𝑚𝑝𝑎𝑛𝑦 𝑐𝑜𝑛𝑛𝑒𝑐𝑡𝑒𝑑 𝑤𝑖𝑡ℎ the relevant knowhow + relevant OCS funding Note: if the OCS Participation Ratio is > 50% the company will not pay more than 50% to the OCS from each payment it receives. 4 Exclusion of certain payments from the OCS Fees Based on the nature of the payments - The OCS may agree that certain amounts that are paid for the Rights will not be taken into account for the calculation of the Total Transaction Amount or the OCS Participation Ratio. Based on timing of the payments - The OCS may agree that amounts that are expected to be paid seven years or more after the date of the grant of the Rights will not be taken into account for the calculation of the Total Transaction Amount. Amounts that were excluded for the purpose of calculation of the OCS Fees may still be subject to royalty payment obligations to the OCS. If the Repayment Amount is lower than the OCS Funding If the company fully paid the OCS Fees and the Repayment Amount is lower than the relevant OCS funding (including interest) – the OCS may require the company to pay the OCS the difference within 14 days. If the OCS determines that the company is not expected to repay the full amount of the relevant OCS funding (including interest) – the OCS may require the company, subject to a hearing, to immediately pay the full amount of the OCS funding (including interest). Exchange of Rights without payment of OCS Fees The OCS may approve the exchange of Rights without any payment to the OCS, if the Rights are exchanged for rights in other know-how, which the OCS determines benefits the Israeli economy substantially more than the Rights that are granted to the relevant non-Israeli. In such case, the know-how received in the exchange will be deemed OCS-funded and will be subject to the limitations and obligations under the R&D Law, including the obligation to pay royalties. The OCS may retroactively cancel the approval for any exchange if the know-how received in Israel in the exchange is not used within 4 months from the date of the approval. Reporting obligations The company must submit an annual report to the OCS signed and approved by a certified accountant starting from the receipt of the OCS approval until the end of the period of the grant of the Rights. The OCS may exempt the company from the submission of the annual report, permanently or for a limited period, in the following cases: (i) the grant of Rights was canceled, (ii) the company paid the full payment concerning the Rights to the OCS, or (iii) the OCS is convinced that there will be no additional payments for the Rights. , 42473 - 2421820/1A 5 This publication is intended as a general guide only. It should not be regarded as legal advice and should not be relied upon. The readers should seek specific professional advice in applying the applicable law to any specific situation. © 2014 Herzog, Fox & Neeman. All rights reserved. Tax notes Sale / License – Prior to any transfer of know-how it will be critical to apply for the proper OCS approval. For example, if a company is licensing OCS-funded know-how but obtains OCS approval for a transfer of know-how by way of a sale, such approval may be used by the Israeli Tax Authority to argue that the transaction was a sale of know-how and not a license, triggering capital gains tax or a deemed dividend. Transfer Pricing - the information that will be provided to the OCS regarding the consideration in licensing transactions may be used by the Israeli Tax Authority and has an obvious implication on transfer pricing matters.