Israel began weighing tax-policy options Sunday after the U.S. Senate over the weekend approved tax cuts that would lower the corporate rate to 20% from 35%, leaving Israel’s headline rate three percentage points higher.
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“The United States made a decision last night to lower taxes . We cannot lag behind in the relief we are giving our business sector regarding both taxes and reduced regulation and bureaucracy,” Prime Minister Benjamin Netanyahu said just before the cabinet cleared measures aimed at trimming the red tape required to start a business.
Finance Minister Moshe Kahlon also said Israel had to address the challenge. “What’s the danger of companies here packing up and moving there? There are many implications. We will have to make adjustments,” he told Channel 10’s weekly politics show "Hamateh."
The Senate’s approval of the wide-ranging tax measures isn’t final because it still has to reconcile its legislation with a tax-cut bill approved by the House of Representatives. But if the proposed corporate rate survives the process, the United States will reverse roles with Israel and become the low-tax country. Israel’s corporate rate, now 24%, is due to ease to 23% next year under a previously approved cut.
Lawyers who specialize in the high-tech sector say the U.S. rate could lure new and existing startups to consider incorporating or reincorporating in the United States and putting their Israelis operations into a wholly owned subsidiary.
That would sting a sector of the economy that accounts for about 14% of the Israeli economy, generates half its industrial exports and employs about one in every 10 workers.
Hanan Haviv, who heads the technology practice at the Tel Aviv law firm Herzog, Fox & Neeman, said that while no one factor determines where a company decides to incorporate, entrepreneurs give a lot of weight to where they think future investors will be coming from and what is important to them.
“The factor that played in Israel’s favor until now was the big difference in the tax rate and other benefits,” he said. “If this advantage disappears, there will be a lot more cases where the scale tips in favor of forming an American company, especially if the funders plan to move to the U.S. at an early stage or expect to raise capital in the U.S.”
In fact, many Israeli companies don’t pay the full corporate tax rate because they are losing money or have accumulated tax credits from previous losses.
Big high-tech companies enjoy lower rates that range from 16% in the center of the country to 9% in the outskirts under the Law for the Encouragement of Capital Investments. Kahlon plans to lower the rate further to between 6% and 12% (the lowest rates for companies that move their intellectual property to Israel) to help Israel’s tech industry.
In the early 2000s, many Israeli startups did incorporate in the United States and operate in Israel through an Israeli subsidiary, mainly because they wanted to be near their prime market, their investors and the U.S. stock market.
“To be an American company was advantageous,” said Michael Barnea, managing partner of the law firm Barnea & Co. “Except that it became clear later that that system involved serious tax consequences because U.S. corporate taxes are the highest in the world. And if you’re a company with business outside the U.S., you needed to transfer all your profits to the American company and lost a lot of money along the way.”
Over the years, Israel coaxed tech companies to domicile in Israel through more attractive tax rates, government research grants, benefits for approved companies and Israel’s growing reputation as a high-tech center. Today some of Israel’s best-known tech companies like Taboola and Wix.com are incorporated in Israel.
“But now, when the rate between the U.S. and Israel isn’t big, the domicile factor is likely to reenter the equation,” Barnea said. “I expect to see a selective return to the old structure. Of course, it will depend on how much confidence there is that the change is for the long term and won’t be reversed with the next presidents."