In 2013 Teva Pharmaceuticals was by far the biggest beneficiary of government subsidies under the Law for Encouraging Capital Investment. Of the 7.7 billion shekels ($2 billion) awarded in aid that year, the giant pharmaceuticals company took 42%.
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The reason for that was a felicitous (for Teva) combination of extraordinary big profits over the decade from 2005 and the company’s decision to take its aid in the form of tax breaks instead of direct aid.
Teva’s best-selling multiple sclerosis drug Copaxone generated the profits and a 2005 amended version of the investment law allowed it to use the tax track to pay zero taxes.
In retrospect, officials now concede the 2005 law was badly thought out. The zero-tax provision was bad enough, but the legislation made it worse by guaranteeing companies that the law would not change for 10 years.
In 2011, the law was amended again and starting this year, Teva will have to pay taxes. The stability clause was removed and a new tax rate for “strategic companies,” of which Teva, as Israel’s biggest company is certainly one, was introduced. Those in the center of the country are entitled to pay a corporate tax of 9% and those in the periphery just 5%.
However, the tax benefit isn’t granted automatically: Companies that want it have to negotiate with the government how much they are prepared to make in capital investments and how many jobs they create.
The assumption was that Teva would enter into talks to win the 5% rate with promises of investment and jobs. But now Israel is inadvertently holding out a tempting third option for Teva that would enable it to pay just a 6% tax rate with no commitment at all.
Under a new tax program contained in the Budget Arrangements Law, Israel will offer high-tech companies with a big component of research and development spending and significant intellectual property portfolios an opportunity to pay a much lower rate of tax: In the center of the country it will go down to 12% from 16% and in the periphery it will unchanged at 9%.
For the biggest companies – those with 10 billion shekels of annual sales or more – the rate falls to 6%.
Israel is offering the tax breaks in response to new policies adopted by the Organization for Economic Cooperation and Development, which has been battling the phenomenon of what it calls base erosion and profit shifting.
Multinational companies use BEPS strategies to exploit gaps and mismatches in tax rules between different countries and artificially shift profits to low or no-tax locations. Under the new OECD framework, one way officials hope to bar the practice is by insisting companies book their IP profits where the IP originated.
For a country like Israel, with its hundreds of multinational R&D centers, this is a potential tax goldmine. But it will only work if tax rates are low enough to keep companies in Israel. And if they are low enough, maybe more companies will decide to open up shop.
Teva fits the criteria for a big high-tech company and could decide to go with the 6% rate. Why would it do that?
It could pay the 9% rate given to export-oriented companies in the periphery or it could pay the 5% for strategic companies, but the latter would require Teva to negotiate investment and employment guarantees. But the 6% rate for tech companies is granted automatically without the need to make any commitments.
The only catch for Teva with the 6% solution is that the government is making no promises that it will keep the rate unchanged for a decade like the 5% for strategic companies.
Officials defend the 6% program on the grounds that it’s designed to attract multinationals and adjust Israel to a new global tax regime. They note that foreign shareholders get other benefits that Israelis don’t, like a 4% dividend tax compared to the ordinary rate of 20%. They also say that without the benefit, even Israeli companies might be inclined to conduct their R&D overseas.
In any case, it looks like the big tax giveaway of the last decade isn’t over. Not just Teva, but Check Point Software technologies – the other big recipient of the breaks – may also opt for the same route. In other words, it’s the biggest and most profitable companies that pay the lowest taxes.