Long in the Background, Government Steps in to Help High-tech

Measures including tax breaks for investors and reorganization of Chief Scientist’s Office aim at revving up a slowing sector.

Ofer Vaknin

After a long hiatus, the government is poised to deepen its involvement in promoting Israel’s technology sector, but not everyone in the industry is looking forward to a new era of bigger government.

The finance and economy ministries have drawn up a list of measures aimed at freeing the flow of local and foreign capital into the industry and helping companies, particularly startups, to attract investment. The most prominent initiative calls for replacing the Office of the Chief Scientist, the division of the Economy Ministry that is responsible for implementing the government’s research and development policy.

Economy Minister Naftali Bennett wants to replace the division with an independent national authority for R&D and innovation to boost economic growth and create jobs. The proposal is slated to go to the ministerial committee on socioeconomic issues shortly. Once it is approved, as expected, it would be included in the Economic Arrangements Bill (hok hahesderim), supplemental legislation to the 2015 state budget.

The new agency would have the authority to make investments, allocate grants to businesses, raise capital in Israel and abroad and establish investment funds. It would also be able to issue loans and guarantees to facilitate local investment. The aim is to create an agency with greater administrative flexibility than the Office of the Chief Scientist, able to introduce new programs without the need for amending legislation each time.

Another proposal that received ministerial approval last week calls for tax breaks for cyber-security companies that move their operations to a dedicated technology park being developed in Be’er Sheva, with the goal of turning the “capital of the Negev “into a global center for the industry. The legislation would give tax credit equal to 20% of their payroll expenses, which is expected to cost the state some 50 million shekels ($14.6 million) a year in lost tax revenues.

The government also seeks to overhaul the “Angels Law,” giving tax breaks to private investors who gamble on startups. The original 2010 law has been pronounced a failure, but a new version unveiled by Bennett and Finance Minister Yair Lapid last Wednesday was approved a day later by the socioeconomic cabinet as part of the Economic Arrangements Law.

“Startups are a strategic growth engine for the economy, so these investments will underpin the future of high-tech and an innovative economy,” Lapid said last week as he and Bennett unveiled the amended Angels Law.

Tax break doubters

But some figures in the industry are dismissive of the cyber tax break. “There is no market failure in cyber. The money being poured into companies is unlimited and there are already exits, so more money will be invested the companies,” says one Israeli venture capitalist. He says the state would do better to encourage sectors where is a market failure, for example by establishing tech accelerators outside of Tel Aviv and Herzliya and funding young biomedical device companies and the nanotechnology industry.

If in the past government intervention in high-tech focused on grants and tax breaks for large companies, most prominently the American semiconductor maker Intel, now the government wants to focus on tools to aid smaller businesses and startups. The government won’t have to put up huge amount of money for these programs at a time when it has to contend with severe budget cuts. The lost tax revenues are seen as manageable.

The Angels Law, for example, would give private investors, or angels, tax breaks that could reach 50 million shekels in the first year to invest in startups.
In the 1990s, the state played a major role in launching Israel’s now world-renowned tech sector, which became a major growth engine for the economy and provided tens of thousands of high-paying jobs.

But since 2003 it has reduced its involvement and, in recent years, the growth rate in high-tech has slowed. Will the new government initiatives succeed like the ones of two decades ago? In recent years the government has not had a good record in creating legislation and institutions to help the industry.

For example, the Comparative Advantage plan promoted in 2009 to 2011 by then-Director General of the Finance Ministry Haim Shani did a good job of mapping the challenges facing the sector, but most of the solutions it offered failed. Some figures say the failure was due to the lack of a single cabinet minister or other high-ranking official with responsibility for the tech sector.

At present, the Angels Law recognizes the tax benefits only after three years and it places stringent conditions on the startup’s operations. Among others, 70% of all investment must be directed to R&D and revenues cannot exceed 50% of R&D spending. Paradoxically, its has encouraged investors to keep the revenues of their companies low so as to qualify for the tax break. Its wording precluded offering financial incentives to investors in Internet and mobile, two of the hottest areas of tech.

Only a few companies ever made use of the law in it current version. The new version does away with these restrictions, and Bennett and other government officials hope it will encourage people who have not risked money in high-tech to give it a try.

“As soon as a startup is approved by the Chief Scientist any investment, up to 5 million shekels, will be considered a tax-deductible expense. This is super-aggressive, with no parallel elsewhere. Its actual impact cannot even be assessed,” Bennett said last week. “I believe hat money from building contractors and from the diamond industry, money that is unrelated to high-tech, will also be brought in ... The law will fuel the economy, leading to the formation of many more startups.”

The treasury’s budget division has no estimate of how much more investment will flow to high-tech with the new Angels Law, but Yonatan Regev, its deputy head, is optimistic. “The government is taking a large part of the risk. In a world with an environment of low interest rates, it will become attractive,” he said.
As for the changes to the OCS, whose origins date back to the 1960s, the office itself is widely considered inadequate and insufficiently flexible to meet the needs of Israel’s rapidly changing high-tech sector.

Failing to consult

But not everyone in the high-tech sector is happy with the proposed changes, although some of that is because officials have failed to consult with the industry in designing its reforms. “If you want to mix private and public money together, you must make sure you don’t forget this principle,” says Yoav Chelouche, cochairman of Israel Advanced Technology Industries,  the largest Israeli organization representing the high-tech and life science industries. The government’s role should be to take on the excess risk or to deal with a market failure, he says.

Benny Zeevi, Chelouche’s co-chairman, notes that previous government attempts to help high-tech have largely been failures. The government is establishing investment funds could create unfair competition with private investment, he says.

“If the chief scientist issues bonds, it will begin to act out of profit motives, since it will need to repay the money – and that’s not its purpose,” explains one high-tech executive, who asked not be named. “It will distort decisions regarding where its support for industry goes and the risks it takes. It is not meant to compete with investment funds or other investors in the private sector.”

Chelouche says the main problems facing the industry are not being dealt with in the new plans, namely the strong shekel and the lack of investment in high-tech by local institutional investors.

Under the OCS shakeup, its 1.2-billion-shekel annual budget would be redirected to the new agency. It would be authorized to independently raise capital and to issue bonds, to establish corporations and acquire an interest in existing ones, all with the aim of creating a closer partnership between the public and private sectors. The OCS’s existing investment program would be turned into a fund that would generate an actual return, which is not an element of its existing R&D aid program.

Of the office’s 32 employees, only 15 would remain, with the rest appointed to other positions at the Economy Ministry. The plan that’s taking shape calls for a new entity to be set up that will report to the ministry and the Office of the Chief Scientist, which will remain responsible for planning and policy development.

The reorganization would also reallocate cabinet responsibilities for the high-tech sector. The economy and finance ministers would be responsible for carrying out the law, but the chairman of the new authority would be appointed by the economy minister alone. The chairman will be the official adviser to the cabinet on issues of R&D, innovation and technology.