by Professor Rifat Azam, Radzyner School of Law, Herzliya
The Israeli Ministry of Finance, in its economic plan and budget bills for the years 2017—2018, has published a very interesting proposal for a preferential tax regime for intellectual property (IP) income, designed to attract multinational investment in Israel, especially IP and knowledge-based investments. The July 28 proposal emphasizes the importance of the high tech industry to the Israeli economy, and seeks to maintain growth and employment in this industry.
The proposal provides for a reduced corporate tax rate on “preferred technology income,” which is defined through a complex definition that separates income attributed to a multinational’s IP from other income. The reduced tax rate is 12% for a “preferred technology establishment” and 6% for a “special preferred technology establishment.”
A business will be designated a “preferred technology establishment” by the Israeli Innovation Authority and Tax Authority based on regulations to be enacted. To be so designated, a company must have averaged at least of 7% of expenses in research and development (R&D) in the last three years and at least 25% of its income must be have been derived from a market with more than 14 million individuals.
In addition, the company must meet at least one of the following criteria: (a) at least 20% of the employees are engaged in R&D; (b) at least USD 2 million is invested in the company through venture capital; (c) the company’s annual income must exceed USD 10 million and must have grown more than 25% each year for the last three years; (d) the company has more than 50 employees and its labor force has grown by more than 25% annually for the last three years.
A “preferred technology establishment” becomes a “special preferred technology establishment” entitled to the 6% reduced corporate tax rate if the firm has worldwide revenues of more than USD 10 billion annually.
In addition to the reduced corporate tax rate as described, qualified multinationals would benefit from similar reduced rates (12% or 6%) on their capital gains from the sale of the IP. This rate applies to any IP that was developed or purchased following the enactment of the law. The determination of whether a company qualifies for the reduced capital gains will be made by the Innovation Authority based on information submitted by the company to the Authority. Trade secrets will be protected according to the current norms and best practices.
Moreover, qualified multinationals also enjoy a reduced (4%) withholding tax on dividends paid to the foreign parent company as long as the dividend is derived from the technology preferred income. The withholding rate may also be reduced if it is so determined by an applicable bilateral tax treaty.
The government states that its proposed preferential regime is consistent with the OECD/G20 base erosion profit shifting (BEPS) final report on action 5 entitled: Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance.
The final report on action 5 adopts the nexus approach, which allows a taxpayer to benefit from an IP regime only to the extent that the taxpayer itself incurred qualifying R&D expenditures that gave rise to the IP income. The nexus approach uses expenditure as a proxy for activity and builds on the principle that, because IP regimes are designed to encourage R&D activities and to foster growth and employment, a substantial activity requirement should ensure that taxpayers benefiting from these regimes did in fact engage in such activities and did incur actual expenditures on such activities.
It seems that the proposed Israeli regime meets the nexus requirements according to action 5. However, action 5 meant is to limit preferential tax regimes instead of encourage them. This development is more evidence that countries’ desire to attract multinational investment is very strong and tax competition continues to prevail. Multinationals would plan their tax strategies wisely to benefit from the proposed Israeli preferential IP tax regime as well as other tax opportunities.
— Rifat Azam is an Associate Professor of Law at Radzyner School of Law, Interdisciplinary Center (IDC) Herzliya, Israel. He researches and teaches in Israel and the United States on issues of international taxation, e-commerce and digital economy taxation, corporate tax avoidance, and the G20/OECD BEPS project. He also consults leading multinationals on international and Israeli tax issues. He can be reached at: [email protected]; [email protected].
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