Amid Changing Directives, Israel Could Benefit in the Realm of Intellectual Property

Extremely belatedly, the world is waking up and starting to protest corporate tax shelters.

Israel Tax Authority offices in Jerusalem.
Lior Mizrahi

The Panama Papers exposé this week, involving millions of documents that leaked from a Panamanian law firm specializing in setting up corporations in tax shelters for the world’s rich, yet again showcased the problem of the rich using tax shelters to dodge tax, legally or otherwise.

Among these well-to-do were not a few shady national leaders, led of course by Russian President Vladimir Putin, and dozens of companies blacklisted in the West because of dealings with terrorism (or Iran, North Korea, Syria or Zimbabwe). This just serves to remind us what a paradise these tax shelters are for scum who use the shelters as a way to rob their people or finance murderous activity.

Israel had its place in the Panama Papers, with some 600 Israeli businessmen exposed as having opened corporations in tax-shelter nations through that same Panamanian law firm. The papers are quite a windfall for the Israel Tax Authority, which is now better equipped to find out whether any of the 600 have been dodging tax.

Note that it is perfectly legal to set up a corporation in a tax shelter, on condition that it report its turnover and profits to the ITA. At least some, however, set up companies using the name of the Panamanian law firm, not their own, precisely in order to hide their income from the taxman. From that perspective, the hackers who stole the Panama Papers and published them are serving the nations in their fight against tax dodgers, a fight that went global in 2008. That crisis slashed national tax revenues, forcing governments to finally get serious about catching and penalizing dodgers.

Yet the biggest tax dodges aren’t done through weird companies listed in Panama or the Virgin Islands. The biggest tax dodges are perpetrated through “tax planning” at multinational companies, which can move profits from one country with onerous tax rules, to another with easier tax rules – and it’s perfectly legal to do so.

The legality of corporate tax planning, which shamelessly moves billions upon billions of dollars from certain European nations and the United States to places like Ireland, Singapore or Bermuda, has made tax planning a global problem, because of its sheer scope and mainly because of the complete inability to contend with perfectly transparent tax machinations.

Intellectual property, physical development

Just now, extremely belatedly, the world is waking up and starting to protest these corporate tax shelters. The main move is being taken by the OECD, which in October 2015 published its first directives on BEPS – Base Erosion & Profit Shifting. The first directives touched on the digital economy and the registration of intellectual property. Both areas are highly relevant to Israel, especially the intellectual property.

The OECD noticed a bizarre dissociation between countries where multinationals develop their technologies and the countries where they register their patents (intellectual property) on these technologies. Switzerland, for instance, has become a superpower for intellectual property registration, thanks to its very low tax rates for companies that register their patents there – just 8.8%. It doesn’t matter to the Swiss where the intellectual property was developed.

Because of that low Swiss tax rate, companies locate their R&D wherever but their management in Switzerland. Thus management gets low tax bills and high mountain air, which is unarguably a lot nicer than Tel Aviv’s smog.

Apropos of which – Tel Aviv is one of Switzerland’s victims. Israel is a development superpower; a lot of multinationals do R&D here – but the fruits of the development in Israel don’t stick around. They get diverted to other countries at cost-plus prices. In other words, the local R&D center reports zero profit and pays zero tax; the entire added value of the development goes to other countries where tax rates are low.

The Andorn Committee, which discussed the investments encouragement law, discussed the intellectual property flight from Israel: “Income from intellectual property occupies a growing place among technology companies and can be migrated with relative ease,” the committee wrote and added that multinational companies tend to choose where to locate their managements and intellectual property based on various considerations, including tax.

The problem is that under the present tax regime, that works against Israel. Switzerland offers comfortable taxation of less than 9%; Ireland and Cyprus dropped it to 2.5%. In Israel, even companies eligible for tax breaks often have to pay the full corporate tax rate of 25% on their intellectual property.

With gaps like that, no wonder Israel is leaking intellectual property like a sieve.

BEPS is supposed to change things by setting new rules for the game. It is supposed to tie between the place of the development and the place where the intellectual property is registered. So if a company has 10 engineers in Switzerland and 90 in Israel, the low Swiss tax rate would only apply to 10% of the intellectual property income.

That opens tremendous opportunity for Israel, but also tremendous risk.

After BEPS comes into force, multinationals will have to choose whether to bring their intellectual property to where their R&D is, or to move their R&D.

Israel is a hub for R&D and most people figure it will gain from BEPS; that the intellectual property will come home. But it isn’t assured. Under the present tax regime, with gaps of 15% to 20%, the risk of Israel not only losing its intellectual property but R&D as well cannot be ignored.

Two obstacles

That is exactly why the Andorn Committee proposes that Israel start granting tax breaks to multinationals on their intellectual property. “Experts assess that... the multinationals will try to locate their intellectual property in countries that combine appropriate infrastructure for R&D with a comfortable tax environment. Today, the system of incentives in the Investment Encouragement law is not ready for the anticipated changes following BEPS. If Israel has the good sense to make the necessary changes, the window of opportunity created by the anticipated regulation changes could be exploited.”

Long story short, the Andorn committee feels that income from intellectual property should be encompassed in the Investment Encouragement legislation, involving lessened tax rates of 9% to 16%, and especially low tax for especially giant companies of 5% to 8%. These breaks, together with Israel’s advantage in R&D, could make BEPS one of the great opportunities Israeli high-tech has seen.

But there are two obstacles. The Israeli public has to accept that the investment encouragement rules need to be expanded, not abolished, which is presently the bent. For the sake of intellectual property , it seems there’s no other choice. The second obstacle is at the Finance Ministry, where Finance Minister Moshe Kahlon has yet to get around to discussing the recommendations of the Andorn Committee, which had been set up by his predecessor.