Innovate Globally, Tax Locally

Israel Seeking to Pull in Foreign Companies With Tax Break Incentives

The government is trying to encourage multinationals to register their intellectual property in Israel.

The Tax Authority and Economy Ministry are planning to introduce new channels under the Law for Encouraging Capital Investment aimed at coaxing the hundreds of multinational companies operating in Israel into registering their intellectual property - patents, trademarks and the like - here rather than abroad.

Intellectual property provides multinationals with billions of dollars of taxable profits a year. Moshe Asher, director general of the Tax Authority, heads a team examining the issue that includes Nahum Itzkowitz, head of the Economy Ministry's Investment Center; Micah Perlman representing the Finance Ministry's budgets division; and Michael Sarel, head of economics and state revenues at the treasury.

The benefit under discussion would apply to intellectual property acquired abroad, such as when an Israeli company buys a European knowledge-based company. Some of the team members, however, want it to also apply to companies whose intellectual property was developed in Israel but registered in another country.

The programs under consideration are tax benefits for companies registering Israel as the base of their intellectual property and for companies headquartered and managed from Israel. In this way Israel would be falling in line with a global trend, one that sustained harsh criticism at the most recent Organization for Economic Cooperation and Development conference of national tax authorities. The trend, termed the "race to the bottom," involves competition between countries to offer the lowest tax rate applicable to multinational companies in order to get these companies to register their intellectual property in their jurisdiction. The OECD has made it clear that it would formulate rules against the trend over the next few years.

The Law for Encouraging Capital Investment offers support programs that include tax benefits for manufacturing and exporting companies. But high-tech companies can't enjoy these tax benefits if their intellectual property was developed and registered abroad. The team will try to check the feasibility of adding a benefits program to induce companies to register patents developed abroad in Israel – and to pay tax on them in Israel.

"We will examine the advantages and disadvantages of recognizing patent and core companies," says a team member, who asked not be identified. "We are discussing whether to expand the Capital Investment Law in this format and, if so, for what type of companies and under what conditions."

"The risk entailed in giving benefits to intellectual property companies is that they'll leave the intellectual property in Israel and export their products to cheaper places," according to a source close to the team. "Therefore the common practice in the world needs to be examined and to determine if it is worth applying in Israel, too. According to initial discussions with foreign companies, the programs are less attractive for large multinationals but medium sized companies are showing interest."

Itzkowitz says the team, which was formed during the previous government, might be expanded to include more members. Its work, he says, is still in the formative stages and lately it was decided to examine benefits offered in countries such as Switzerland, Ireland, and Greece which have led foreign companies into registering their intellectual property there. "It's not only a way to collect more taxes but also a way to generate more jobs in Israeli high tech," according to Itzkowitz.

"We want to see if it's possible to formulate a package that will convince multinational high-tech companies, including 300 that already have research and development centers in Israel but are taking their intellectual property abroad, to register their intellectual property in Israel," adds Itzkowitz. "The subject can't be examined only in terms of taxation and state revenues, and other aspects need to be considered like keeping the development centers and production in Israel and establishing core companies so that the human capital will remain here."

On the other hand, another team member thinks the team won't deal with the intellectual property of multinationals operating in Israel on a "cost-plus" basis such as Google. According to this system, the parent company registered abroad totes up the expenses of its Israeli subsidiary and adds 10% which it deems as profit. The tax paid in Israel is on the 10% alone. "It seems the cost-plus method can't be discontinued," according to a team member. "This is a business model accepted throughout the world that also has economic advantages in that it ensures there will always be profit – however modest."

"There are no doubt positive aspects to the willingness by multinational high-tech companies to operate in Israel, but there are also elements which could hurt us and it's important to look at the overall picture," says Daphne Getz of the Samuel Neaman Institute, who performed a study on R&D output in Israel. "A growing percentage of patents is registered abroad and Israel is losing the ability to create assets from this knowledge. If we want to develop industry and a growing, sustainable economy here, we need to make sure that the lion's share of inventions by Israelis remains in Israel."

According to her study, multinational-owned R&D centers registered 27% of the patents recorded by Israel's private sector in 2011 and in the past decade the number has grown by 144%, from 409 in 2000 to 998 in 2011.

Former deputy governor of the Bank of Israel, Zvi Eckstein, headed another study for the Chief Scientist to examine the reasons for Israel high-tech's low productivity, calculated in terms of sales per employee. The study found that although multinationals hire Israel's best R&D people, their contribution to the economy is questionable in terms of taxes collected, employment, and spillover of know-how to other companies.

The study prepared for Eckstein's team disclosed that multinationals account for 40% of the overall R&D investment in Israel, a figure that includes R&D workers in Israel employed by the multinationals. Although the small sample size didn't permit unequivocal conclusions, it was seen that Israel's high-tech productivity is similar to that in the U.S. but that the gap widened in the second half of the previous decade.

Based on figures from the statistics bureau, the study prepared for Eckstein's team also found that between 2007 and 2009 average pay at the multinationals' development centers exceeded the pay received at Israeli companies working in the same fields or large companies competing for the same manpower by 53%.

"The wage gap raises the question of whether there is knowledge spillover from the development centers to the Israeli market, something which could justify government support, or if the outstanding workers are hired by the development centers while know-how and innovation remain with the multinationals and have no effect whatsoever on the economy," it said.

Bloomberg
Tomer Neuberg