The Finance Ministry has been under terrific pressure to abolish tax breaks for big business. But the pressure stems mostly from an illusion.
The illusion is that Israel could collect NIS 2 billion more if it exposes the shadow economy, and another NIS 3 billion from taxing trapped profits. Neither is likely, though.
Why? Because the Knesset hasn't even approved measures to fight the shadow economy; and as for the trapped profits – there is a big conceptual error here.
Let’s be clear: The trapped profits are the sorry result of the previous version of the Encouragement of Capital Investments Law. It spared companies from paying corporate tax on profits not distributed as dividends.
Since only the companies themselves decide when to share profits as dividends – if ever – then there is never any way, for all practical purposes, to collect taxes from them. Tax collection depends entirely on the companies’ willingness to pay dividends.
Knowing he could not get companies to pay dividends by force, Finance Minister Yuval Steinitz tried persuasion. He promised them a lower tax rate if they were willing to pay out dividends in 2013. Although Finance Ministry officials hope the companies will take the bait and take advantage of the lower tax rate to pay out dividends, there is no way of knowing to what extent they will do so.
This being the case, NIS 3 billion in tax revenue from trapped profits can be compared to the two proverbial birds in the bush: nobody knows when they’ll end up in the hand, if ever.
Cui bono? Big business
In the law's new version, enacted two years ago, the concept of trapped profits no longer exists. All profit, shared or not, is taxed at the same rate.
In its attempt to move away from the unworkably complicated old law, the new Encouragement of Capital Investments Law is wonderfully simple. All exporters – those who export more than 25 percent of their product – must pay a reduced corporate tax rate of 12 percent if they are located in the center of the country, and six percent if they are located in the periphery.
Some of the large companies, such as Teva Pharmaceutical Industries, are allowed to pay an even lower corporate tax rate of only five percent. That's it. The law is beautifully simple.
According to the State Revenue Administration’s latest statistics, which were updated last in 2008, the amount of tax benefits the Encouragement of Capital Investments Law provided was NIS 5.6 billion – a 19-percent increase within a single year that has evidently continued since then. On top of that, this whole huge benefit ended up going to Israel’s own large export firms.
The five large export companies –Teva, Israel Chemicals, Check Point Software Technologies, Iscar and perhaps Intel Israel – wound up with 72 percent of the benefit. These big, strong companies, which hardly need help from the state, receive tax benefits amounting to NIS 4 billion from it every year. Small companies fighting for their lives get only crumbs.
The lack of logic and fairness in these statistics has led to calls to repeal the Encouragement of Capital Investments Law. During a year when the Finance Ministry is desperately seeking ways to abolish tax exemptions, why not repeal the Encouragement of Capital Investments Law, with its regressive tax exemption?
It would be a good idea, but as far as anyone can tell, the Finance Ministry is not considering it. It will, at most, consider making slight changes, for many reasons.
The main reason is that it has no choice. The big, strong companies are much better able to force their will on the state, so the state has no choice but to give in. It’s a fact that all over the world, governments give in to the large companies and use tax benefits to entice them to invest.
“Teva is no longer an Israeli company, so it’s not sentimental,” Finance Ministry officials say. “The global corporations could just pick up and leave if being here wasn’t worth their while, and it’s easier to do that now than in the past.”
When they say “easier,” they’re referring to the issue of transfer pricing: the prices that the company’s factories along the production chain pay one another. This is how global corporations whose product is assembled in several countries work: The basic component is made in China, the assembly process takes place in India and Israel and the item is sold in the United States as a finished product.
Such companies have no problem diverting profits from one country to another by changing the sale price for each component along the production chain. Raising the tax in Israel, for example, could lead to a situation where the Chinese factory doubles the price of the component that it manufactures for the Israeli factory, thus diverting the profit from Israel to China.
The issue of transfer pricing is a well-known problem. Israel, too, has been swept unwillingly into this race between countries. But Finance Ministry officials are trying to show that the glass is still at least half full. The new law improves the situation somewhat. It taxes the global firms at five percent instead of the old law’s zero percent, and in any case only large exporters enjoy the benefits the law provides.
In addition, Finance Ministry officials show research about the enormous contribution these giant corporations make to Israel’s economy in employment, management infrastructure development, and technology. They claim that Israel benefits from having the companies here even at such low tax rates. “The price of error is enormous,” ministry officials say. “Is it better to make a mistake in favor of Intel and pay it too much while having it stay here, or make an error not in its favor and risk having it leave? If we repeal the Encouragement of Capital Investments Law, we will harm investments in Israel very badly without increasing our tax revenue all that much.”
But this view is overly dogmatic. In the power equation between Israel and the global corporations, Israel isn’t the only one with something to lose. Companies that have already established production facilities here, at a huge investment, would not be happy to see those facilities go idle.
Even though it looks like the existing balance of power won’t allow Israel to repeal the Encouragement of Capital Investments Law, the state can still make slight changes in the benefits the law provides. It’s not at all certain that changing the current rates of six percent for companies in outlying areas to 10 percent, and 12 percent for companies in the center of the country to 15 percent, would make Israel less attractive to investors. In the current situation, with the Finance Ministry scrambling to bring in tax revenue from every possible direction, this option should be considered.
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