Attention All Companies: Here Is the Tax That Will Make You Rich

The Law for the Encouragement of Capital Investment made it possible for the biggest companies to get more in benefits than they pay to the state.

The Law for the Encouragement of Capital Investment bestowed NIS 5.6 billion in tax benefits on companies throughout the country in 2010, of which NIS 4 billion ‏(nearly 70% of the total‏) went to Israel’s four largest exporters − in all likelihood Teva Pharmaceutical Industries, Israel Chemicals, Intel and Check Point Software.

In fact, the benefits received by the four companies under the framework of this law were huge enough to place them in the position of owing the state negative tax. They paid the state NIS 1.1 billion in taxes − corporate tax or income tax on employees’ pay − and received back NIS 4 billion in benefits. Yes, the country gave them NIS 2.9 billion more in tax money than they paid in.

The fact that the state is a net disburser of money to large, profitable companies is an aberration unmatched by any other area of taxation, including the same law as applied to other companies. Every other company to which the law applies pays more taxes than it gets back in benefits. Only for the same handful of exporters is the situation reversed.

Thus the Encouragement of Capital Investment Law is, beyond doubt, the most regressive element of Israel’s tax code. The richer and more powerful you are, the less tax you pay. And if you’re in the top 1%, as these companies are, the state will pay you more tax refunds than the taxes you pay in.

How did we reach this paradoxical situation?

In looking at the State Revenue Administration’s report for 2003 to 2010, several answers emerge − for better or worse. The most problematic answer, which should keep every Israeli up at night, is the existence of huge disparities among Israeli companies. To be specific, we have four or five good and strong world-leading industrial concerns, with all the rest strung out behind.

According to figures from the report, between 2003 and 2010 the profits of the four largest companies grew by 470%, while those of the other 99% of industrial companies grew by just 29%.

Concentrated profits

As a result of the leap forward by the four largest companies − in which the jump in Israel Chemicals’ potash prices and the success of Teva’s Copaxone drug probably played a major role − their tax benefits also soared. It’s basically good news that Israeli companies are very profitable. But it’s not very good news when it turns out the increase in profits is concentrated among four or five companies, including one which is actually a foreign company ‏(Intel‏), one which happened to get lucky and benefit from natural resources ‏(Israel Chemicals‏) and another company whose main development − Copaxone − is losing steam ‏(Teva‏).

In any case, it wasn’t just the increase in profits and investments of the giant companies that brought about the jump in their tax benefits at the expense of all the rest: It was also the ultra-generous terms they received from the government − nil tax on large investments of unlimited size − that helped them immensely. Since 2006, the tax benefits for enormous companies has been on an upward swing due to changes in the law magnifying the benefits − the chief one, and most drastic of all, being the strategic track benefit for 0% tax reserved for only the largest companies.

Due to this strategic track, the State of Israel barely enjoys any tax revenues from one of the most brilliant products ever developed here: Teva’s Copaxone, manufactured under the protection of 0% tax for 10 years. But since Copaxone is becoming exposed to global competition, when the 10 years are up Israel won’t be seeing any significant share of tax from the drug that originated in the labs of the Weizmann Institute of Science. In this case, the mistake in creating a 0% tax track cost the State of Israel billions of shekels that can’t be restored.

Historical figures

The over-the-top benefits to large companies ultimately forced the state to make changes to the law. The figures published Sunday by the State Revenue Administration belong to history since they relate to the old capital investment law. The new law, which took effect in 2011 and whose effect on corporate-tax payments will only be felt toward the end of the decade, is an attempt to correct some of the old aberrations.

The 0% track for giant companies, for instance, is replaced by a 5% track, and regular exporters can enjoy a much reduced tax rate of 6% in the peripheral regions and 12% in the center of the country. The new law is also very simple: The only criterion is to export 25% of the plant’s output.

The State Revenue Administration expects the new law to make the range of benefits under the Law for the Encouragement of Capital Investment much more equitable: More small exporters will be covered by the law, with nearly equal conditions to those of the huge companies. The red tape that kept small companies from benefiting from the old law has been removed. The threshold of just 25% production for export has made it much easier on small companies. The gap in reduced tax rates was also greatly narrowed in favor of the small companies: Teva’s Copaxone plant at Ramat Hovav will be paying 5% tax in the future, but every small exporter in the Negev will also now be eligible to a 6% rate.

Teva’s advantage over small exporters, therefore, has become insignificant − at least in terms of the benefit rate. In terms of the size of the benefit, however, Teva is expected to continue raking in most of the money simply because it’s a huge exporter.

The main question is whether this is all bad. Moreover, since Israel only has four or five big and successful exporters, the question of whether Israel can afford not to serve their interests is a delicate one. Teva is thought to have chosen to establish its Copaxone production in Israel, and Intel to build its huge factory in Israel, largely thanks to the benefits from the Law for the Encouragement of Capital Investment. Could these benefits be changed considering the risk of losing the few successful companies operating here?

This is the question lying at the government’s doorstep today as it considers whether to again change the benefits provided by the law − just two years after amending it the first time. The lessons of the past teach us that Israel exaggerated with the benefits it granted large companies, but the lessons also attest to the importance of the law in providing Israel with returns.

The conclusion that must be reached is that the law is important, but must be correctly calibrated in terms of the size of benefits and their distribution. The new law, which greatly simplified the eligibility threshold, allows the benefits to be distributed more equitably and encourages small companies to also become exporters.

However, the three reduced tax rates under the new law can certainly be raised and still be considered attractive benefits when compared with Israel’s corporate tax rate ‏(on its way to 26%‏), as well as in terms of tax benefits throughout the world.

Bloomberg